SmartKem, Inc. 10-K

Item 8. Financial Statements and Supplementary Data ​ ​ ​ ​ ​ SmartKem, Inc. ​ ​ Index to Consolidated Financial Statements ​ ​ ​ Page ​ Report of Independent Registered Public Accounting Firm (BDO LLP: London, United Kingdom: PCAOB ID # 1295 ) 47 ​ Consolidated Balance Sheets as of December 31, 2021 and 2020 48 ​ Consolidated Statements of Operations and Comprehensive Loss for the years ended December 31, 2021 and 2020 49 ​ Consolidated Statements of Stockholders' Equity for the years ended December 31, 2021 and 2020 50 ​ Consolidated Statements of Cash Flows for the years ended December 31, 2021 and 2020 51 ​ Notes to the Consolidated Financial Statements 52 ​ ​ 46 Table of Contents Report of Independent Registered Public Accounting Firm ​ Shareholders and Board of Directors SmartKem, Inc. Manchester, United Kingdom Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of SmartKem, Inc. (the “Company”) as of December 31, 2021 and 2020, the related consolidated statements of operations and comprehensive loss, stockholders’ equity, and cash flows for each of the two years in the period ended December 31, 2021, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2021, in conformity with accounting principles generally accepted in the United States of America. Going Concern Uncertainty The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has suffered recurring losses from operations and has a net capital deficiency that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Basis for Opinion These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. 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 audits 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 consolidated 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 audits 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 audits included performing procedures to assess the risks of material misstatement of the consolidated 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 consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. ​ /s/ BDO LLP ​ BDO LLP ​ We have served as the Company's auditor since 2020. Manchester, United Kingdom March 28, 2022 ​ 47 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Consolidated Balance Sheets (in thousands, except number of shares and per share data) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ December 31, ​ 2021 2020 ASSETS ​ ​ ​ ​ ​ ​ ​ ​ ​ Current assets: ​ ​ Cash and cash equivalents ​ $ 12,226 ​ $ 764 Accounts receivable ​ — ​ 18 Research and development tax credit receivable ​ 1,070 ​ 982 Prepaid expenses and other current assets ​ 802 ​ 259 Total current assets ​ 14,098 ​ 2,023 Property, plant equipment, net of accumulated depreciation of $ 1,102 and $ 908 ​ 802 ​ 682 Right-of-use assets, net ​ 154 ​ 236 Other assets ​ 6 ​ 8 Total assets ​ $ 15,060 ​ $ 2,949 ​ ​ ​ ​ ​ ​ ​ LIABILITIES AND STOCKHOLDERS' EQUITY ​ ​ ​ ​ ​ ​ ​ ​ ​ Accounts payable and accrued expenses ​ $ 1,423 ​ $ 861 Current lease liabilities ​ 87 ​ 217 Total current liabilities ​ 1,510 ​ 1,078 Non-current lease liabilities ​ 28 ​ 20 Total liabilities ​ 1,538 ​ 1,098 ​ ​ ​ ​ ​ ​ ​ Commitments and contingencies (Note 9) ​ ​ ​ ​ ​ ​ Stockholders’ Equity: ​ ​ Common stock, par value $ 0.0001 per share, 300,000,000 shares authorized, 25,554,309 and 13,627,887 shares issued and outstanding , at December 31, 2021 and December 31, 2020, respectively* ​ 3 ​ 1 Additional paid-in capital ​ 89,954 ​ 61,276 Accumulated other comprehensive loss ​ ( 1,363 ) ​ ( 1,480 ) Accumulated deficit ​ ( 75,072 ) ​ ( 57,946 ) Total Stockholders’ equity ​ 13,522 ​ 1,851 ​ ​ ​ ​ ​ ​ ​ Total Liabilities and Stockholders’ Equity ​ $ 15,060 ​ $ 2,949 * Please refer to Note 1 The accompanying notes are an integral part of these consolidated financial statements. ​ 48 Table of Contents ​ SMARTKEM, INC. AND SUBSIDIARIES Consolidated Statements of Operations and Comprehensive Loss (in thousands, except number of shares and per share data) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Year Ended December 31, ​ 2021 2020 Revenue ​ $ 18 ​ $ 94 Cost of revenue ​ 8 ​ 55 Gross profit ​ 10 ​ 39 ​ ​ ​ ​ ​ ​ ​ Other operating income ​ 1,285 ​ 1,437 ​ ​ ​ ​ ​ ​ ​ Operating Expenses: ​ ​ Research and development ​ 8,199 ​ 4,319 Selling, general and administrative ​ 8,069 ​ 1,707 Transaction expenses ​ 1,329 ​ — Total operating expenses ​ 17,597 ​ 6,026 ​ ​ ​ ​ ​ ​ ​ Loss from operations ​ ( 16,302 ) ​ ( 4,550 ) ​ ​ ​ ​ ​ ​ ​ Non-operating (Expense)/Income ​ ​ (Loss) on foreign currency transactions ​ ( 808 ) ​ — Other income ​ ​ — ​ ​ 1 Interest expense ​ ( 19 ) ​ ( 6,835 ) Interest income ​ 3 ​ 3 Change in fair value of derivative asset ​ — ​ ( 6,282 ) Loss on conversion of convertible notes payable ​ — ​ ( 5,470 ) Total non-operating (expense) ​ ( 824 ) ​ ( 18,583 ) ​ ​ ​ ​ ​ ​ ​ Loss before income taxes ​ ( 17,126 ) ​ ( 23,133 ) Income tax expense ​ — ​ — Net loss ​ $ ( 17,126 ) ​ $ ( 23,133 ) ​ ​ ​ ​ ​ ​ ​ Net loss ​ $ ( 17,126 ) ​ $ ( 23,133 ) Other comprehensive loss: ​ ​ Foreign currency translation ​ 117 ​ ( 284 ) Total comprehensive loss ​ $ ( 17,009 ) ​ $ ( 23,417 ) ​ ​ ​ Basic & diluted net loss per common share ​ $ ( 0.68 ) ​ $ ( 1.80 ) ​ ​ ​ ​ ​ ​ ​ Basic & diluted weighted average shares outstanding ​ ​ 25,233,384 ​ ​ 12,821,748 ​ The accompanying notes are an integral part of these consolidated financial statements. ​ ​ 49 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders’ Equity (in thousands, except share data) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Accumulated ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Additional ​ Other ​ ​ ​ ​ ​ ​ ​ ​ Common stock ​ Paid-in ​ Comprehensive ​ Accumulated ​ Stockholders’ ​ Shares Amount Capital Loss Deficit Equity (Deficit) Balance at January 1, 2020 2,183,885 ​ $ - ​ $ 30,926 ​ $ ( 1,196 ) ​ $ ( 34,813 ) ​ $ ( 5,083 ) Issuance of common stock 2,548,877 ​ - ​ 4,592 ​ - ​ - ​ 4,592 Conversion of notes and interest 8,895,125 ​ 1 ​ 25,758 ​ - ​ - ​ 25,759 Foreign currency translation adjustment - ​ - ​ - ​ ( 284 ) ​ - ​ ( 284 ) Net loss - ​ - ​ - ​ - ​ ( 23,133 ) ​ ( 23,133 ) Balance at December 31, 2020 ​ 13,627,887 ​ ​ 1 ​ ​ 61,276 ​ ​ ( 1,480 ) ​ ​ ( 57,946 ) ​ ​ 1,851 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Accumulated ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Additional ​ Other ​ ​ ​ ​ ​ ​ ​ ​ Common stock ​ Paid-in ​ Comprehensive ​ Accumulated ​ Stockholders’ ​ Shares Amount Capital Loss Deficit Equity (Deficit) Balance at January 1, 2021 ​ 13,627,887 ​ $ 1 ​ $ 61,276 ​ $ ( 1,480 ) ​ $ ( 57,946 ) ​ $ 1,851 Issuance of common shares due to exercise of stock-options 1,424,622 ​ 1 ​ 19 ​ - ​ - ​ 20 Stock-based compensation expense - ​ - ​ 6,196 ​ - ​ - ​ 6,196 Repurchase of common stock ( 2,307,700 ) ​ - ​ - ​ - ​ - ​ - Effect of reverse capitalization 2,500,000 ​ - ​ - ​ - ​ - ​ - Issuance of common shares to vendor 147,500 ​ - ​ 280 ​ - ​ - ​ 280 Issuance of common stock and warrants in private placement 10,162,000 ​ 1 ​ 24,637 ​ - ​ - ​ 24,638 Issuance costs related to common stock and warrants in private placement - ​ - ​ ( 2,454 ) ​ - ​ - ​ ( 2,454 ) Foreign currency translation adjustment - ​ - ​ - ​ 117 ​ - ​ 117 Net loss - ​ - ​ - ​ - ​ ( 17,126 ) ​ ( 17,126 ) Balance at December 31, 2021 ​ 25,554,309 ​ ​ 3 ​ ​ 89,954 ​ ​ ( 1,363 ) ​ ​ ( 75,072 ) ​ ​ 13,522 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ The accompanying notes are an integral part of these consolidated financial statements. ​ ​ 50 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (in thousands) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Year Ended December 31, ​ ​ 2021 2020 Cash flows from operating activities: ​ ​ ​ Net loss ​ $ ( 17,126 ) ​ $ ( 23,133 ) Adjustments to reconcile net loss to net cash used in operating activities: ​ ​ Depreciation ​ 209 ​ 197 Common shares issued to vendor for services ​ 263 ​ — Amortization of right of use asset ​ 234 ​ 176 Stock-based compensation ​ ​ 6,196 ​ ​ — Non-cash interest expense ​ — ​ 6,835 Change in fair value of embedded conversion feature ​ — ​ 6,282 Loss on conversion of convertible notes payable ​ — ​ 5,470 Change in operating assets and liabilities: ​ ​ ​ Accounts receivable, net ​ 19 ​ ( 17 ) Research & development tax credit receivable ​ ( 104 ) ​ 551 Prepaid expenses and other current assets ​ ( 532 ) ​ ( 70 ) Accounts payable and accrued expenses ​ 579 ​ ( 214 ) Lease liabilities ​ ( 276 ) ​ ( 157 ) Other assets ​ 2 ​ ( 2 ) Net cash used in operating activities ​ ( 10,536 ) ​ ( 4,082 ) ​ ​ ​ ​ ​ ​ ​ Cash flows from investing activities: ​ ​ Purchases of property, plant and equipment ​ ( 341 ) ​ ( 118 ) Net cash used by investing activities ​ ( 341 ) ​ ( 118 ) ​ ​ ​ ​ ​ ​ ​ Cash flows from financing activities: ​ ​ Proceeds from term loan payable ​ 738 ​ — Repayment of term loan payable ​ ​ ( 738 ) ​ ​ — Proceeds from the issuance of common stock ​ ​ — ​ ​ 4,592 Proceeds from the issuance of common stock and warrants in private placement ​ 24,638 ​ — Payment of issuance costs ​ ( 2,454 ) ​ — Proceeds from the exercise of stock options ​ 20 ​ — Net cash provided by financing activities ​ 22,204 ​ 4,592 ​ ​ ​ ​ ​ ​ ​ Effect of exchange rate changes on cash ​ 135 ​ ( 40 ) ​ ​ ​ ​ ​ ​ ​ Net change in cash ​ 11,327 ​ 392 ​ ​ ​ ​ ​ ​ ​ Cash, beginning of year ​ 764 ​ 412 Cash, end of year ​ $ 12,226 ​ $ 764 ​ ​ ​ ​ ​ ​ ​ Supplemental disclosure of cash and non-cash investing and financing activities ​ ​ Cash paid for income taxes ​ $ — ​ — Cash paid for interest ​ $ 19 ​ — Right of use asset and lease liability additions ​ $ 136 ​ — Issuance of common shares for consulting services ​ $ — ​ — Conversion of debt and accrued interest into common shares ​ $ — ​ 25,759 ​ The accompanying notes are an integral part of these consolidated financial statements. ​ ​ 51 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ 1. BUSINESS AND LIQUIDITY Organization & Reverse Recapitalization SmartKem Inc. (“SmartKem” or the “Company”) a Delaware corporation, formerly known as Parasol Investments Corporation (“Parasol”), was formed on May 13, 2020 and is the successor, as discussed below, of SmartKem Limited, which was formed under the Laws of England and Wales. The Company was founded as a “shell” company registered under the Exchange Act, with no specific business plan or purpose until it began operating the business of SmartKem Limited following the closing of the Exchange described below. On February 23, 2021 Parasol entered into a Securities Exchange Agreement (“the Exchange Agreement”), with SmartKem Limited. Pursuant to the Exchange Agreement all of the equity interests in SmartKem Limited, except certain deferred shares which had no economic or voting rights (the “Deferred Shares”) and which were purchased by Parasol for an aggregate purchase price of $ 1.40 , were exchanged for shares of Parasol common stock, par value $ 0.0001 per share (“common stock”), and SmartKem Limited became a wholly owned subsidiary of Parasol (the “Exchange”). ​ As a result of the Exchange, Parasol legally acquired the business of SmartKem Limited, and continues as the existing business operations of SmartKem Limited as a public reporting company under the name SmartKem, Inc. ​ Under ASC 805, Business Combinations, SmartKem Limited was deemed the accounting acquirer based on the following predominate factors: Parasol was created as a “shell” company to effect a business combination and had no operations, the former shareholders of SmartKem Limited own more than a majority of the outstanding voting stock of the Company, the Company’s board of directors and management consists of the former board of directors and management of SmartKem Limited, SmartKem Limited was the largest entity by assets at the time of the Exchange, and the principal operating location of the Company is SmartKem Limited’s premises which are located in Manchester, United Kingdom. ​ The Exchange was accounted for as a reverse recapitalization, with no goodwill or other intangible assets recorded, in accordance with accounting principles generally accepted in the United States of America (“US GAAP”). Under this method of accounting, Parasol was treated as the “acquired” company for financial reporting purposes. Accordingly, for accounting purposes, the Exchange was treated as the equivalent of SmartKem Limited issuing stock for the net assets of Parasol, accompanied by a recapitalization. The net assets of Parasol are stated at historical cost, with no goodwill or other intangible assets recorded. The consolidated assets, liabilities, and results of operations prior to the Exchange are those of SmartKem Limited. Reported shares and earnings per share available to holders of the Company’s common stock, prior to the Exchange, have been retroactively restated as shares reflecting the exchange ratios established in the Exchange. ​ At the closing of the Exchange (the “Closing”), each SmartKem Limited ordinary share issued and outstanding immediately prior to the Closing (other than the Deferred Shares) was exchanged for 0.0111907 of a share of the Company’s common stock and each SmartKem Limited A ordinary share issued and outstanding immediately prior to the Closing was exchanged for 0.0676668 of a share of the Company’s common stock, with the maximum number of shares of our common stock issuable to the former holders of SmartKem Limited’s ordinary shares and A ordinary shares equal to 12,725,000 . This includes enterprise management incentive options to purchase 124,497,910 SmartKem Limited ordinary shares (the “SmartKem Limited EMI Options”) issued and outstanding immediately prior to the Closing that were accelerated and exercised by the holders thereof for a like number of ordinary shares and exchanged for shares of the Company’s common stock pursuant to the Exchange. In aggregate 1,127,720,477 SmartKem Ltd shares were exchanged for 12,725,000 of the Company’s common stock, an average exchange ratio of 0.011283825 . Immediately prior to the Closing, an aggregate of 2,500,000 shares of the Company’s common stock owned by the stockholders of Parasol prior to the Exchange were forfeited and cancelled (the “Stock Forfeiture”). ​ 52 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ Business SmartKem, Inc. is seeking to reshape the world of electronics with a revolutionary semiconductor platform that enables a new generation of displays, sensors and logic. SmartKem’s patented TRUFLEX® inks are solution deposited at a low temperature, on low-cost substrates to make organic thin-film transistor (OTFT) circuits. The company’s semiconductor platform can be used in a number of applications including mini-LED displays, AMOLED displays, fingerprint sensors and logic circuits. SmartKem develops its materials at its research and development facility in Manchester, UK and its semiconductor manufacturing process at the Centre of Process Innovation (CPI) in Sedgefield, UK. The company has an extensive IP portfolio including approximately 120 issued patents. COVID-19 Pandemic In March 2020, the World Health Organization declared the outbreak of COVID-19 as a global pandemic (the “Pandemic”). The Pandemic has had a widespread and detrimental effect on the global economy and has adversely impacted the Company’s business and results of operations. The Company has experienced travel bans, states of emergency, quarantines, lockdowns, “shelter in place” orders, business restrictions and shutdowns in the countries where it operates. The Company’s containment measures have impacted its day-to-day operations and disrupted its business. Because the severity, magnitude and duration of the Pandemic and its economic consequences are highly uncertain, rapidly changing and difficult to predict, the ultimate impact of the Pandemic on the Company’s business, financial condition and results of operations is currently unknown. The additional costs incurred by the Company related to COVID-19 for the year ended December 31, 2021 were deemed to be immaterial to the consolidated financial statements. The Company anticipates there may be additional costs relating to the Pandemic incurred in the upcoming months that will be attributable to fiscal year 2022 and thereafter. These costs are not expected to be material. The consolidated entity presented is referred to herein as “SmartKem”, “we”, “us”, “our”, or the “Company”, as the context requires and unless otherwise noted. ​ 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Basis for Presentation These consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission and accounting principles generally accepted in the United States of America ( “US GAAP”) as defined by the Financial Accounting Standards Board (FASB) within the FASB Accounting Standards Codification (“ASC”) and are presented in thousands, except number of shares and per share data . Going Concern The accompanying consolidated financial statements have been prepared on the basis of continuity of operations, realization of assets and the satisfaction of liabilities, and commitments in the ordinary course of business. Since inception, we have incurred recurring losses including net losses of $ 17.1 million and $ 23.1 million for the years ended December 31, 2021 and 2020, respectively. As of December 31, 2021, we had an accumulated deficit of $ 75.1 million. We anticipate operating losses to continue for the foreseeable future due to, among other things, costs related to research funding, further development of our technology and products and expenses related to the commercialization of our products. We expect that our cash and cash equivalents of $ 12.2 million as of December 31, 2021 will be sufficient to fund our operating expenses and capital expenditure requirements through at least 12 months from the issuance date of these consolidated financial statements through the first quarter of 2023. It is possible this period could be shortened if there 53 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ are any significant increases in planned spending or development programs or more rapid progress of development programs than anticipated. Our future viability is dependent on our ability to raise additional capital to fund our operations. In the long-term, 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. 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. There can be no assurance however that such financing will be available in sufficient amounts, when and if needed, on acceptable terms or at all. The precise amount and timing of the funding needs cannot be determined accurately at this time, and will depend on a number of factors, including the market demand for the Company’s products and services, the quality of product development efforts, management of working capital, and continuation of normal payment terms and conditions for purchase of services. If the Company is unable to substantially increase revenues, reduce expenditures, or otherwise generate cash flows for operations, then the Company will need to raise additional funding to continue as a going concern. Basis of Consolidation The consolidated financial statements include the accounts of SmartKem, Inc. and its wholly-owned subsidiaries, SmartKem Delaware, Inc. and SmartKem Limited. The Company does not have any nonconsolidated subsidiaries. All intercompany balances and transactions have been eliminated on consolidation, including unrealized gains and losses on transactions between the companies. The Company's formerly wholly-owned subsidiary, SmartKem Delaware Inc. was dissolved on May 13, 2021. Comprehensive loss Comprehensive loss of all periods presented is comprised primarily of net loss and foreign currency translation adjustments. Management’s Use of Estimates The preparation of consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, including disclosure of contingent assets and liabilities, at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. The most significant estimates in the Company’s consolidated financial statements relates to the valuation of common share, fair value of share options, fair value of embedded conversion features in the convertible notes, and the valuation allowance of deferred tax assets. These estimates and assumptions are based on current facts, historical experience and various other factors believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of expenses that are not readily apparent from other sources. Due to the uncertainty of factors surrounding the estimates or judgments used in the preparation of the consolidated financial statements, actual results may materially vary from these estimates. Certain Risk and Uncertainties The Company’s activities are subject to significant risks and uncertainties including the risk of failure to secure additional funding to properly execute the Company’s business plan. The Company is subject to risks that are common to companies in the growth stage, including, but not limited to, development by the Company or its competitors of new technological innovations, dependence on key personnel, reliance on third party manufacturers, protection of proprietary 54 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ technology, and compliance with regulatory requirements. See Item 1a of this Form 10-K for a fuller discussion of the Company’s risk factors. The Company has access under a framework agreement to equipment which is used in the manufacturing of demonstrator products employing the Company’s inks. If the Company lost access to this fabrication facility, it would materially and adversely affect the Company’s ability to manufacture prototypes and demonstration products for potential customers. The loss of this access could significantly impede the Company’s ability to engage in product development and process improvement activities. Alternative providers of similar services exist, but would take effort and time to bring into the Company’s operations. Cash and Cash Equivalents The Company considers all highly liquid investments purchased with original maturities of 90 days or less at acquisition to be cash equivalents. As of December 31, 2021 and 2020, the Company did no t have any cash equivalents. Accounts Receivable Accounts receivable are stated at the amount the Company expects to collect and do not bear interest. The Company considers the following factors when determining the collectability of specific customer accounts: customer credit-worthiness, past transaction history with the customer, current economic industry trends, and changes in customer payment terms. These receivables have historically been paid timely. Due to the nature of the accounts receivable balance, the Company believes there is no significant risk of non-collection. If the financial condition of the Company’s customers were to deteriorate, adversely affecting their ability to make payments, allowances for doubtful accounts would be required. There was no allowance for doubtful accounts recorded as of December 31, 2021 and 2020. Concentrations of Credit Risk Financial instruments that potentially subject the Company to significant concentration of credit risk consist primarily of cash and cash equivalents and accounts receivable. Periodically, the Company maintains deposits in financial institutions in excess of government insured limits. Management believes that the Company is not exposed to significant credit risk as the Company’s deposits are held at financial institutions that management believes to be of high credit quality and the Company has not experienced any losses in these deposits. Property, Plant and Equipment Property, plant and equipment is stated at cost, less accumulated depreciation. Maintenance and repairs are expensed when incurred. Additions and improvements that extend the economic useful life of the asset are capitalized and depreciated over the remaining useful lives of the assets. The cost and accumulated depreciation of assets sold or retired are removed from the respective accounts, and any resulting gain or loss is reflected in current earnings. Depreciation and amortization are provided using the accelerated declining balance method in amounts considered to be sufficient to amortize the cost of the assets to operations over their estimated useful lives. Property, plant and equipment is depreciated at 25 percent of net book value on an annual basis, resulting in an estimated useful life of approximately 15 years . Impairment of Long-Lived Assets Management continually evaluates whether events or changes in circumstances might indicate that the remaining estimated useful life of long-lived assets may warrant revision, or that the remaining balance may not be recoverable. When factors indicate that long-lived assets should be evaluated for possible impairment, the Company uses an estimate of the related undiscounted cash flows in measuring whether the long-lived asset should be written down to fair value. Measurement of the amount of impairment would be based on generally accepted valuation methodologies, as deemed 55 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ appropriate. If the carrying amount is greater than the undiscounted cash flows, the carrying amount of the asset is reduced to the asset’s fair value. An impairment loss is recognized immediately as an operating expense in the consolidated statements of operations. Reversal of previously recorded impairment losses are prohibited. As of December 31, 2021 and 2020, Company’s management believed that no revision to the remaining useful lives or impairment of the Company’s long-lived assets was required. Derivative Asset for Embedded Conversion Features The Company does not use derivative instruments to hedge exposures to cash flow, market, or foreign currency risks. The Company evaluates 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 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 are estimated using a Monte Carlo simulation model, in which possible outcomes and their values are simulated repeatedly and randomly. Under the Monte Carlo method the Company 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. Fair Value of Financial Instruments ​ ASC 820, Fair Value Measurements , provides guidance on the development and disclosure of fair value measurements. Under this accounting guidance, fair value is defined as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. ​ The accounting guidance classifies fair value measurements in one of the following three categories for disclosure purposes: ​ Level 1: Quoted prices in active markets for identical assets or liabilities. ​ Level 2: Inputs other than Level 1 prices for similar assets or liabilities that are directly or indirectly observable in the marketplace. ​ Level 3: Unobservable inputs which are supported by little or no market activity and values determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant judgment or estimation. ​ Fair value measurements discussed herein are based upon certain market assumptions and pertinent information available to management as of and during the years ended December 31, 2021 and 2020. The carrying value of the 56 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ Company’s cash, accounts receivable, other receivables, prepaid expenses and other current assets, accounts payable and accrued expenses approximate fair value because of the short-term maturity of these financial instruments. The carrying value of derivative asset is displayed at fair value. See Note 8 for additional information regarding fair value measurements. Convertible Notes The Company accounts for its convertible notes in accordance with ASC 470-20, Debt with Conversion and Other Options (“ASC 470-20”), which requires the liability and equity components of convertible debt instruments to be separately accounted for in a manner that reflects the issuer’s nonconvertible debt borrowing rate. Debt discount created by the bifurcation of embedded feature in the convertible notes are reflected as a reduction to the related debt liability. The discount is amortized to interest expense over the term of the debt using the effective-interest method. Warrants The accounting treatment of warrants issued is determined pursuant to the guidance provided by ASC 480, Distinguishing Liabilities from Equity , and ASC 815, Derivatives and Hedging , as applicable. Each feature of a freestanding financial instrument including, without limitation, any rights relating to subsequent dilutive issuance, dividend issuances, equity sales, rights offerings, forced conversions, dividends, and exercise are assessed with determinations made regarding the proper classification in the Company’s consolidated financial statements. The Company determined that all warrants meet the criteria to be classified as equity. Leases Operating lease assets are included within operating lease right-of-use assets, and the corresponding operating lease obligation on the consolidated balance sheets as of December 31, 2021 and 2020. The Company has elected not to present short-term leases as these leases have a lease term of 12 months or less at lease inception and do not contain purchase options or renewal terms that the Company is reasonably certain to exercise. All other lease assets and lease liabilities are recognized based on the present value of lease payments over the lease term at commencement date. Because most of the Company’s leases do not provide an implicit rate of return, the Company used an incremental borrowing rate based on the information available at adoption date in determining the present value of lease payments. Revenue The Company applies the provisions of ASC 606, Revenue from Contracts with Customers . The Company recognizes revenue under the core principle to depict the transfer of control to the Company’s customers in an amount reflecting the consideration the Company expects to be entitled to. In order to achieve that core principle, the Company applies the following five step approach: (1) identify the contract with a customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contact and (5) recognize revenue when a performance obligation is satisfied. The Company’s current contracts with customers do not contain significant estimates or judgments. All of the Company’s revenue contains a single performance obligation that is recognized upon fulfilment of the sales order. The Company derives its revenues primarily from sales of demonstrator units to customers evaluating organic semiconductor technology. The transaction price is stated in each customer agreement and is allocated to a single performance obligation. Revenue is recognized upon shipment of each demonstrator, at a point in time. The Company 57 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ does not have any significant financing components as payment is received at or shortly after the point of sale. Costs incurred to obtain a contract will be expensed as incurred when the amortization period is less than a year. Research and Development Expenses The Company expenses research and development costs as incurred. Research and development costs include salaries, employee benefit costs, direct project costs, supplies and other related costs. Advance payments for goods and services that will be used in future research and development activities are expensed when the activity has been performed or when the goods have been received. Patent and Licensing Costs Patent and licensing costs are expensed as incurred because their realization is uncertain. These costs are classified as research and development expenses in the accompanying consolidated statements of operations and comprehensive loss. Other Operating Income The Company’s other operating income is related to government grant incentives received for qualifying research and development projects, and research and development tax credits related to the United Kingdom’s Research and Development Expenditure Credit scheme, which is a government tax incentive designed to reward innovative companies for investing in research and development. Such incentives are recorded as other income when it is probable the amounts are collectible and can be reasonably estimated. For the year ended December 31, 2021 and 2020, the Company recorded grant income and research & development tax credits of $ 1,285 thousand and $ 1,437 thousand, respectively, which are recorded as other operating income in the accompanying consolidated statements of operations. As of December 31, 2021, and December 31, 2020, the Company had receivables related to research & development tax credits for payments not yet received of $ 1,070 thousand and $ 982 thousand, respectively. Ordinary Shares Valuation ​ Due to the absence of an active market for the Company’s ordinary shares, the Company utilized methodologies in accordance with the framework of the American Institute of Certified Public Accountants Technical Practice Aid, Valuation of Privately-Held Company Equity Securities Issued as Compensation, to estimate the fair value of its ordinary shares. In determining the exercise prices for options to be issued, the estimated fair value of the Company’s ordinary shares on each grant date was estimated based upon a variety of factors, including: ● the issuance prices of ordinary shares; ● the rights and preferences of preferred shareholders; ● the progress of the Company’s research and development programs; ● the Company’s stage of development and business strategy; ● external market conditions affecting the technology industry and trends within the technology industry; ● the Company’s financial position, including cash on hand; ● the Company’s historical and forecasted performance and operating results; ● the lack of active public market for the Company’s ordinary shares; ● the likelihood of achieving a liquidity event, such as a securities offering, initial public offering or a sale of the Company’s shares. ​ 58 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ Significant changes to the key assumptions underlying the factors used could result in different fair values of ordinary shares at each valuation date. ​ Ordinary shares are classified in shareholders’ equity and represent issued share capital. Share-based compensation All share-based payments, including grants of stock options, are measured based on the fair value of the share-based awards at the grant date and recognized over their respective vesting periods. Outstanding options generally expire 10 years after the grant date. The Company has issued options that vest based on service requirements and issued options that vest based on performance requirements. Options become exercisable when service requirements are met. In the case of performance based options, options become exercisable when there is a liquidity event, such as a change in control or sale or admission (listing as a public company or initial public offering (“IPO”)), and the employee, or consultant, must be providing services to the Company at the time of the event. Due to the Exchange, all options outstanding immediately prior to the event with a performance obligation requirement became vested and exercisable. Non-cash stock-based compensation expense for the year ended December 31, 2021 was $ 6,196 thousand (see also Note 11). The estimated fair value of stock options at the grant date is determined using the Black-Scholes pricing model. The Black-Scholes option pricing model requires inputs such as the fair value of common stock on date of grant, expected term, expected volatility, dividend yield, and risk-free interest rate. The assumptions used in calculating the fair value of stock-based awards represent management’s best estimates and involve inherent uncertainties and the application of management’s judgment. As a result, if factors change and management uses different assumptions, stock-based compensation expense could be materially different for future awards. The Company records forfeitures when they occur. Functional Currency and Operations Prior to the Exchange, SmartKem Limited’s (“the predecessor’s”) functional currency was the British Pound Sterling (“GBP”), and the consolidated financial statements were presented in United States dollars (“USD”). The predecessor’s functional currency was the respective local currency of the primary economic environment in which an entity’s operations are conducted. The predecessor translated the consolidated financial statements into the presentation currency using exchanges rates in effect on the balance sheet date for assets and liabilities and average exchanges rates for the period for statement of operations accounts, with the difference recognized in accumulated other comprehensive income/ (loss). ​ The Company’s functional currency is the U.S. dollar (“USD”). The functional currency of the Company’s foreign operation is the respective local currency. Assets and liabilities of foreign operation denominated in local currencies are translated at the spot rate in effect at the applicable reporting date. The consolidated statements of operations and comprehensive loss are translated at the weighted average rate of exchange during the applicable period. The resulting unrealized gain/loss is recognized as foreign currency translation as a component of other comprehensive income. Income Taxes Income taxes are recorded in accordance with ASC 740, Income Taxes (“ASC 740”), which provides for deferred taxes using an asset and liability approach. The Company recognizes 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. 59 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ The Company accounts for uncertain tax positions in accordance with the provisions of ASC 740. When uncertain tax positions exist, the Company recognizes the tax benefit of tax positions to the extent that the benefit would more likely than not be realized assuming examination by the taxing authority. The determination as to whether the tax benefit will more likely than not be realized is based upon the technical merits of the tax position as well as consideration of the available facts and circumstances. The Company recognizes any interest and penalties accrued related to unrecognized tax benefits as income tax expense. As of December 31, 2021 and 2020, there were no material uncertain tax positions. Contingent Liabilities A provision for contingent liabilities is recorded when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. With respect to legal matters, provisions are reviewed and adjusted to reflect the impact of negotiations, estimated settlements, legal rulings, advice of legal counsel and other information and events pertaining to a particular matter. The Company is a party to certain litigation and disputes arising in the normal course of business. As of December 31, 2021, the Company does not expect that such matters will have a material adverse effect on the Company’s business, financial position, results of operations, or cash flows. Offering Costs Direct and incremental legal and accounting costs associated with the Company’s issuance of common stock and warrants are deferred and classified as a component of other assets on the consolidated balance sheet until completion of the issuance. Upon completion of the issuance, deferred offering costs are reclassified from other assets to equity in additional paid-in capital and recorded against the net proceeds received in the issuance. The deferred offering costs incurred as of December 31, 2020 were immaterial and no offering costs were capitalized. For the year ended December 31, 2021 $ 2,454 thousand of offering costs were recorded in additional paid-in capital. For the year ended December 31, 2021, $ 1.329 million of direct and incremental costs associated with the Exchange were recorded as Transaction Expenses in the Consolidated Statement of Operations and Comprehensive Loss. Segment Information The Company has determined that it operates and reports in one segment , which focuses on the development of materials and processes used to make organic thin-film transistors (OTFTs) for the manufacture of flexible electronics. The Company’s operating segment is reported in a manner consistent with the internal reporting provided to the chief operating decision maker (“CODM”). The Company’s CODM has been identified as its Chairman and Chief Executive Officer. Basic and Diluted Loss Per Share Basic and diluted net loss per share is determined by dividing net loss by the weighted average ordinary shares outstanding during the period. For all periods presented with a net loss, the shares underlying the ordinary share options and warrants have been excluded from the calculation because their effect would be anti-dilutive. Therefore, the weighted-average shares outstanding used to calculate both basic and diluted loss per share are the same for periods with a net loss. ​ The loss per share information in these consolidated financial statements is reflected and calculated as if the Company had existed since January 1, 2020. Accordingly, loss per share for all periods was calculated based on the number of shares retroactively adjusted for the exchange ratio determined in the reverse recapitalization (see also note 1). 60 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ The Company has 2,168,000 pre-funded common stock warrants outstanding as of December 31, 2021, which became exercisable on April 23, 2021 based on terms and conditions of the agreements. As the pre-funded common stock warrants are exercisable for $ 0.01 , these shares are considered outstanding common shares and included in computation of basic and diluted Earnings Per Share as the exercise of the pre-funded common stock warrants is virtually assured. The Company included these pre-funded common stock warrants in basic and diluted earnings per share when all conditions were met on April 23, 2021. ​ The following potentially dilutive securities have been excluded from the computation of diluted weighted average shares outstanding as they would be anti-dilutive: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ December 31, ​ 2021 2020 Options ​ ​ 1,953,882 ​ ​ 1,810,749 Warrants ​ 985,533 ​ — Total ​ ​ 2,939,415 ​ ​ 1,810,749 ​ Recent Accounting Pronouncements In June 2016, the FASB issued Accounting Standards Update (“ASU”) No. 2016-13, Financial Instruments: Credit Losses (Topic 326) , which requires measurement and recognition of expected losses for financial assets held. The new standard changes the impairment model for most financial instruments, including trade receivables, from an incurred loss method to a new-forward looking approach, based on expected losses. The estimate of expected credit losses will require organizations to incorporate considerations of historical information, current conditions and reasonable and supportable forecasts. The standards update is effective prospectively for annual and interim periods in fiscal years beginning after December 15, 2019, with early adoption permitted, for U.S. Securities Exchange filer, excluding entities eligible to be smaller reporting companies. The standards update is effective prospectively for annual and interim periods beginning after December 15, 2022. Management is currently evaluating the impact of these changes on the consolidated financial statements. In May 2021, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2021-04, Earnings Per Share (Topic 260), Debt—Modifications and Extinguishments (Subtopic 470-50), Compensation—Stock Compensation (Topic 718) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40). The amendments in this update affect all entities that issue freestanding written call options (for example warrants) that are classified in equity. Specifically, the amendments affect those entities when a freestanding equity-classified written call option is modified or exchanged and remains equity classified after the modification or exchange. The amendments that relate to the recognition and measurement of EPS for certain modifications or exchanges of freestanding equity-classified written call options affect entities that present EPS in accordance with the guidance in Topic 260, Earnings Per Share. The amendments in this update are effective for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. Management is currently evaluating the impact of this guidance but does not expect this update to have a material impact on the Company's consolidated financial statements. In November 2021, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2021-10, Government Assistance (Topic 832), Disclosures by Business Entities about Government Assistance. The amendments in this update affect all business entities that account for a transaction with a government by applying a grant or contribution accounting model by analogy to other accounting guidance. The amendments in this Update require annual disclosures about: (1) Information about the nature of the transactions and the related accounting policy used to account for the transactions; (2) The line items on the balance sheet and income statement that are affected by the transactions, and the amounts applicable to each financial statement line item; and (3) Significant terms and conditions of the transactions, including commitments and contingencies. The amendments in this update are effective for all entities within their scope for financial statements 61 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ issued for annual periods beginning after December 15, 2021. Management is currently evaluating the impact of this guidance but does not expect this update to have a material impact on the Company's consolidated financial statements. Reclassifications Certain amounts in prior years' consolidated financial statements have been recast and reclassified to conform to the current year's presentation . ​ ​ 3. PREPAID EXPENSES AND OTHER CURRENT ASSETS: Prepaid expenses and other current assets consist of the following: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ December 31, ​ 2021 2020 Prepaid rent ​ $ 58 ​ $ 65 Prepaid utilities ​ 51 ​ 30 Prepaid insurance ​ 412 ​ 41 Prepaid administrative expenses ​ 63 ​ 61 Prepaid technical fees ​ ​ 141 ​ ​ 8 Prepaid consulting fees ​ ​ 27 ​ ​ — VAT receivable ​ 50 ​ 54 Total prepaid expenses and other current assets ​ $ 802 ​ $ 259 ​ ​ As of December 31, 2021 and 2020, there was $ 217 thousand and $ 0 , respectively, of non-current prepaid insurance related to directors’ and officers’ liability insurance that was included in the amounts above. ​ ​ 4. PROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment consist of the following: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ December 31, ​ 2021 2020 Plant and equipment ​ $ 1,633 ​ $ 1,316 Furniture and fixtures ​ 245 ​ 248 Computer hardware and software ​ 26 ​ 26 ​ ​ 1,904 ​ 1,590 Less: Accumulated depreciation ​ ( 1,102 ) ​ ( 908 ) Property, plant and equipment, net ​ $ 802 ​ $ 682 ​ Depreciation expense was $ 209 thousand and $ 197 thousand for the year ended December 31, 2021 and 2020, respectively, and is classified as research and development expense. ​ 62 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ 5. ACCOUNTS PAYABLE AND ACCRUED EXPENSES: Accounts payable and accrued expenses consist of the following: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ December 31, ​ 2021 2020 Accounts payable ​ $ 510 ​ $ 227 Accrued expenses – lab refurbishments ​ 131 ​ 132 Accrued expenses – technical fees ​ 66 ​ 45 Accrued expenses – variable rent & utilities ​ 20 ​ 67 Accrued expenses – audit & accounting fees ​ 191 ​ 250 Accrued expenses – other ​ 112 ​ 6 Credit card liabilities ​ 10 ​ 6 Payroll and social security liabilities ​ 383 ​ 128 Total accounts payable and accrued expenses ​ $ 1,423 ​ $ 861 ​ ​ 6. LEASES: The Company has operating leases consisting of office space, lab space, and equipment with remaining lease terms of 1 to 3 years , subject to certain renewal options as applicable. There was no sublease rental income for the year ended December 31, 2021 and 2020. The Company is not the lessor in any lease agreement, and no related party transactions for lease arrangements have occurred. ​ The table below presents certain information related to the lease costs for the Company’s operating and finance leases for the periods ended: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ For the Year Ended December 31, ​ 2021 2020 Operating lease cost ​ $ 225 ​ $ 175 Short-term lease cost ​ 32 ​ 48 Variable lease cost ​ 140 ​ 401 Total lease cost ​ $ 397 ​ $ 624 ​ The total lease cost is included in the consolidated statements of operations as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ For the Year Ended December 31, ​ ​ 2021 2020 Research and development ​ $ 373 ​ $ 562 Selling, general and administrative ​ 24 ​ 62 Total lease cost ​ $ 397 ​ $ 624 ​ ​ 63 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ Right of use lease assets and lease liabilities for our operating leases were recorded in the consolidated balance sheets as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ December 31, ​ 2021 2020 Assets ​ ​ ​ Operating lease right of use assets ​ $ 154 ​ $ 236 Total lease assets ​ $ 154 ​ $ 236 Liabilities ​ ​ Current liabilities: ​ ​ Operating lease liability – current portion ​ $ 87 ​ $ 217 Noncurrent liabilities: ​ ​ Operating lease liability, net of current portion ​ 28 ​ 20 Total lease liabilities ​ $ 115 ​ $ 237 ​ The Company had no right of use lease assets and lease liabilities for financing leases as of December 31, 2021 and 2020. The table below presents certain information related to the cash flows for the Company’s operating leases for the periods ended: ​ ​ ​ ​ ​ ​ ​ ​ For the Year Ended December 31, ​ 2021 2020 Operating cash outflows from operating leases $ 276 ​ $ 157 Supplemental non-cash amounts of operating lease liabilities arising from obtaining right of use assets $ 136 ​ $ — ​ The table below presents certain information related to the weighted average remaining lease term and the weighted average discount rate for the Company’s operating and finance leases as of the period ended: ​ ​ ​ ​ ​ ​ ​ ​ ​ For the Year Ended December 31, ​ 2021 ​ 2020 Weighted average remaining lease term (in years) – operating leases ​ 1.40 ​ 1.35 Weighted average discount rate – operating leases ​ 6.07 % ​ 6.30 % ​ 64 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ Undiscounted operating lease liabilities as of December 31, 2021, by year and in the aggregate, having non-cancelable lease terms in excess of one year were as follows: ​ ​ ​ ​ ​ ​ As of ​ ​ December 31, ​ ​ 2021 2022 ​ $ 93 2023 ​ 22 2024 ​ 7 2025 ​ — 2026 ​ — Thereafter ​ — Total undiscounted lease payments ​ 122 Less future minimum short-term lease payments ​ ​ ( 3 ) Less imputed interest ​ ( 4 ) Total net lease liabilities ​ $ 115 ​ ​ 7. CONVERTIBLE NOTES AND NOTES PAYABLE: Convertible Notes The activity for the Company’s convertible notes during the years ended December 31, 2021 and 2020 was as follows: ​ ​ ​ ​ ​ ​ ​ ​ For the Year Ended December 31, ​ 2021 2020 Balance, beginning of year $ — ​ $ 7,280 Amortization of debt discount ​ — ​ ​ 25 Extinguishment of debt discount ​ — ​ ​ 6,767 Loss on conversion of note ​ — ​ ​ 9,344 Conversion of notes to equity ​ — ​ ​ ( 23,630 ) Foreign currency translation ​ — ​ ​ 214 Balance, end of year $ — ​ $ — ​ On January 24, 2020, a Qualified Financing Event (as defined below) occurred when the Company received cumulative investment proceeds in excess of $ 4,600 thousand from the sale and issuance of common shares. The fair value of the Company’s common shares were $ 1.807011 per share. The 2018 BASF Venture Capital and Entrepreneurs Fund L.P. Notes (as defined below), 2018 Octopus Investment Limited Notes (as defined below), and the 2019 Octopus, EF, and Other Notes (as defined below) in the aggregate principal amount of $ 11,796 thousand were converted into 8,159,977 of common shares (at the discounted price of $ 1.45 per share), and the related unpaid and accrued interest totaling $ 1,063 thousand were also converted into 735,148 of A Ordinary common shares of the Company (at the discounted price of $ 1.45 per share). The Company recognized a loss on conversion of $ 5,470 thousand for the year ended December 31, 2020 related to the conversion of notes measured as the difference in carrying value of debt and accrued interest and the fair value of shares converted on the conversion date. As a result of the conversion, the Company also recognized the unamortized debt discount related to the beneficial conversion feature of $ 6,767 thousand as interest expense for the year ended December 31, 2020. For the year ended December 31, 2020, the Company incurred an effective interest rate of 13.5 % relating to convertible notes. There were no convertible notes outstanding as of December 31, 2021 and 2020. There was interest expense recognized based on the debt’s stated interest for the year ended December 31, 2021 and 2020 of zero and $ 43 65 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ thousand, respectively, relating to convertible notes. Additional interest expense related to the amortization of debt issuance cost was zero and $ 25 thousand for the year ended December 31, 2021 and 2020, respectively, for convertible notes. Loss on the conversion of notes is included on the consolidated statements of operations and other comprehensive loss as loss on conversion of convertible notes payable. The amount displayed in the statements of operations and other comprehensive loss for the year ended December 31, 2020 is inclusive of the loss on notes in the amount of $ 9,344 thousand, loss on accrued interest in the amount of $ 1,046 thousand and offset by the gain on the extinguishment of derivative liability in the amount of $ 4,920 thousand (Note 8). 2018 BASF Venture Capital and Entrepreneurs Fund L.P. Notes On April 18, 2018, the Company entered into a convertible note agreement (the “2018 BASF Venture Capital and Entrepreneurs Fund L.P. Notes”), with BASF Venture Capital (“BASF”) and Entrepreneurs Fund L.P. (“EF”) with an aggregate principal of $ 5,862 thousand. The 2018 BASF/EF Convertible Note was issued in three separate tranches on April 18, 2018, July 20, 2018 , and December 28, 2018 . The 2018 BASF Venture Capital and Entrepreneurs Fund L.P. Notes and accrued but unpaid interest were convertible into the common share based on (i) fund raising at a price paid per Senior Share equal to the price paid per Senior Share by the investors on a Fund Raising at a discount to the per share price in the Fund Raising, (ii) sale of the company at a price per Senior Share of $ 16.39 , or (iii) listing of the company on a publicly traded market at a price per Senior Share of $ 16.39 . The principal amount shall accrue interest at a rate of 8 % per annum, from the Issue Date up until the first anniversary of the Issue Date. Interest shall accrue on the principal amount at a rate of 15 % per annum from, and including, the first anniversary of the Issue Date up until the notes are (i) converted, cancelled, repaid or redeemed or (ii) the longstop date. Accrued interest was to be calculated on the basis of a 365 -day year for the actual number of days elapsed. 2018 Octopus Notes On July 20, 2018 the Company entered into a convertible note agreement (the “2018 Octopus Investment Limited Notes”) with Octopus Investment Limited (“Octopus”) with an aggregate nominal amount of $ 2,622 thousand. The 2018 Octopus Convertible Note was issued in two separate tranches on July 20, 2018 and December 28, 2018 . The 2018 Octopus Notes and accrued but unpaid interest were convertible into the common shares based on (i) fund raising at a price paid per Senior Share equal to the price paid per Senior Share by the investors on a Fund Raising at a discount, (ii) sale of the company at a price per Senior Share of $ 15.10 , or (iii) listing of the company on a publicly traded market at a price per Senior Share of $ 15.10 . The principal amount shall accrue interest at a rate of 8 % per annum, from the Issue Date up until the first anniversary of the Issue Date. Interest shall accrue on the principal amount at a rate of 12 % per annum from, and including, the first anniversary of the Issue Date up until the notes are (i) converted, cancelled, repaid or redeemed or (ii) the longstop date. Accrued interest was to be calculated on the basis of a 365 -day year for the actual number of days elapsed. 2019 Octopus, EF, and Other Notes On June 26, 2019 the Company entered into a convertible note agreement (the “2019 Octopus, EF, and Other Notes”) with Octopus, EF, and various private investors with an aggregate nominal amount of $ 3,681 thousand. The 2019 Octopus Convertible Note was issued in two separate tranches on June 26, 2019 and September 23, 2019 . The 2018 Octopus, EF, and Other Notes and accrued but unpaid interest were convertible into the common shares based on (i) fund raising at a price paid per Senior Share equal to the price paid per Senior Share by the investors on a Fund Raising at a discount, (ii) sale of the company at a price per Senior Share of $ 0.001861 , (iii) listing of the company 66 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ on a publicly traded market at a price per Senior Share of $ 14.61 , or (ii) any date following the first anniversary of the date the of the Instrument at a price per Senior Share of $ 11.19 . The principal amount shall accrue interest at a rate of 10 % per annum, from the Issue Date up until the notes are (i) converted, cancelled, repaid or redeemed or (ii) the longstop date. Accrued interest was to be calculated on the basis of a 365 -day year for the actual number of days elapsed. The issuance of convertible notes with a beneficial redemption feature resulted in a debt discount of $ 2,608 thousand. ​ ​ ​ ​ Notes Payable On January 26, 2021, the Company entered into a term loan facility agreement for the amount of $ 738 thousand. The funds were available to be drawn on from the effective date of the agreement through to January 27, 2021. The Company drew down the full loan amount on January 26, 2021. The Company’s research and development tax credit was to be utilized as collateral. The Lender was to be paid immediately following payment of research and development tax credit from the United Kingdom’s HM Revenue and Customs. The final repayment was due six months from the agreement date, if the loan and any interest was not repaid in full prior to this date. The loan carried a monthly interest rate of 1.25 %. The interest accrued daily and compounded monthly on the monthly anniversary of the draw down date of the loan. For year ended December 31, 2021, the Company incurred an effective interest rate of 26.20 % relating to notes payable. There were no notes payable outstanding during for the year ended December 31, 2020. The interest expense recognized based on the debt’s effective interest rate for year ended December 31, 2021 and 2020, was $ 19 thousand and zero , respectively, relating to notes payable. The Company repaid the note payable in full on March 2, 2021. There were no notes payable outstanding as of December 31, 2021 and 2020. ​ 8. DERIVATIVE ASSET: The table below provides a summary of the changes in fair value of the derivative asset measured on a recurring basis using significant unobservable inputs (Level 3) during the years ended December 31, 2021: ​ ​ ​ ​ ​ ​ ​ ​ For the Year Ended December 31, ​ 2021 2020 Balance, beginning of year $ — ​ $ 1,407 Loss on fair value of derivative asset included in earnings ​ — ​ ​ ( 6,282 ) Gain on extinguishment of derivative asset upon conversion ​ — ​ ​ 4,920 Foreign currency translation ​ — ​ ​ ( 45 ) Balance, end of year $ — ​ $ — ​ The Embedded Conversion Features are separately measured at fair value, with changes in fair value recognized in current operations. The original values of the Embedded Conversion Features were recorded as a derivative asset with the offset as a debt premium to the Convertible Notes which is being amortized over the term of the Convertible Notes. During the year ended December 31, 2020, all outstanding convertible notes were converted into equity. The derivative asset was marked to market on the date of conversion and derecognized at conversion. The change in fair value of derivative asset included in earnings was $ 6,282 thousand for the year ended December 31, 2020. The gain on extinguishment of derivative asset upon conversion is $ 4,920 thousand and is recorded as an offset within the loss on conversion of convertible notes payable on the consolidated statements of operations and comprehensive loss. ​ There were no convertible notes outstanding during the year ended December 31, 2021, and no associated derivative asset during the year. 67 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ ​ 9. COMMITMENTS AND CONTINGENCIES: Legal proceedings In the normal course of business, the Company may become involved in legal disputes regarding various litigation matters. In the opinion of management, any potential liabilities resulting from such claims would not have a material effect on the consolidated financial statements. ​ Capital expenditure commitments contracted for but not yet incurred totaled $ 1,422 thousand and primarily consists of purchase commitments in the normal course of business for research & development services, communications infrastructure and administrative services. ​ ​ ​ ​ ​ 10. STOCKHOLDERS’ EQUITY: Common Stock ​ Voting Rights ​ Each holder of common stock is entitled to one vote for each share on all matters submitted to a vote of the stockholders, including the election of directors. The Company’s amended and restated certificate of incorporation and the Company’s amended and restated bylaws do not provide for cumulative voting rights. The holders of one-third of the stock issued and outstanding and entitled to vote, present in person or represented by proxy, shall constitute a quorum for the transaction of business at all meetings of the stockholders. Dividends The Company has never paid any cash dividends to shareholders and do not anticipate paying any cash dividends to shareholders in the foreseeable future. Any future determination to pay cash dividends will be at the discretion of our board of directors and will be dependent upon financial condition, results of operations, capital requirements and such other factors as the board of directors deems relevant. Market Information ​ Quotations on our common stock on the OTC Market Group’s OTCQB® Market quotation system (“OTCQB”) commenced under the ticker symbol “SMTK” in February 2022. There was no trading of our common stock on the OTCQB or any other over-the-counter market prior to February 2022. ​ Preferred Stock ​ The Company currently has no shares of preferred stock outstanding, and the Company has no present plan to issue any shares of preferred stock. The board of directors has the authority, without further action by the stockholders, to issue up to 10,000,000 shares of preferred stock in one or more series and to fix the rights, preferences, privileges and restrictions thereof. These rights, preferences, and privileges could include dividend rights, conversion rights, voting rights, redemption rights, liquidation preferences, sinking fund terms, and the number of shares constituting any series or the designation of such series, any or all of which may be greater than the rights of common stock. 68 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ ​ Common Stock Warrants On February 23, 2021, a total of 985,533 fully vested common stock warrants were issued to a vendor for financial advisory services provided in connection with the sale of the Company’s common stock . The common stock warrants are exercisable at a per share price of $ 2.00 until they expire on February 23, 2026. During the year ended December 31, 2021, no warrants issued to vendors for financial advisory services were exercised. The grant date fair value for these warrants of $ 0.91 per warrant for a total fair value of $ 896 thousand, was determined using the Black-Scholes options valuation model. The Company recorded the warrants at fair value, as both an increase and decrease in additional paid-in capital during the year ended December 31, 2021. A summary of the Company’s warrants to purchase common stock activity is as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Weighted- ​ ​ ​ ​ ​ ​ ​ Average ​ ​ ​ ​ Weighted- ​ Remaining ​ ​ ​ ​ Average ​ Contractual ​ ​ Number of ​ Exercise ​ Term ​ ​ Shares ​ Price ​ (Years) Warrants outstanding at January 1, 2021 — ​ $ — — Exercised — ​ — — Forfeited or Expired — ​ — — Granted 985,533 ​ 2.00 5.00 Warrants outstanding at December 31, 2021 985,533 ​ $ 2.00 4.15 ​ On February 23, 2021, a total of 2,168,000 pre-funded common stock warrants were issued to investors with an exercise price of $ 0.01 per share for total proceeds to the Company of $ 4,314 thousand. During the year ended December 31, 2021, no warrants issued to investors were exercised. The grant date fair value for these warrants of $ 1.99 is based on the stock price at issuance date of $ 2.00 less the exercise price of $ 0.01 . The pre-funded common stock warrants have no expiration date and terminate upon exercise. A summary of the Company’s pre-funded warrants to purchase common stock activity is as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Weighted- ​ ​ ​ ​ Average ​ ​ Number of ​ Exercise ​ ​ Shares ​ Price Pre-funded warrants outstanding at January 1, 2021 — ​ $ — Exercised — ​ — Forfeited or Expired — ​ — Granted 2,168,000 ​ 0.01 Pre-funded warrants outstanding at December 31, 2021 2,168,000 ​ $ 0.01 ​ ​ 69 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ The grant date fair value of common stock warrants is determined using the Black-Scholes option-pricing model. There was no public trading market for our shares before February 2022 and the Company estimates its expected stock volatility based on historical volatility of publicly traded peer companies. The following assumptions were used during the year ended December 31, 2021: ​ ​ ​ ​ ​ Year Ended ​ December 31, 2021 Expected term (years) 5 years Risk-free interest rate 0.60 % Expected volatility 54 % Expected dividend yield 0 % ​ There were no common stock warrants issued during the year ended December 31, 2020. ​ 11. SHARE-BASED COMPENSATION: Prior to the Exchange discussed in Note 1, SmartKem Limited had stock option plans. SmartKem Limited stock options discussed below have been retroactively restated as options reflecting the exchange ratios established in the Exchange. SmartKem Limited had issued Enterprise Management Incentive options (“EMI Options”) and non-tax-advantaged options ( “Unapproved Options”) to eligible employees, officers, non-employee directors and other individual service providers as a means for them to develop a sense of proprietorship and personal involvement in the development and financial success of SmartKem Limited and to encourage them to devote their best efforts to the business of SmartKem Limited, thereby advancing the interests of SmartKem Limited and its shareholders. Options were issued to certain employees and service providers under the investment agreement dated July 15, 2014, which provided for the grant of up to 175,292 options. On December 14, 2018, the Company entered into a written resolution, which allowed SmartKem Limited to grant up to 458,316 options. SmartKem Limited adopted a new Investment Agreement (the “Agreement”) dated January 24, 2020, SmartKem Limited, by means of the Agreement, seeks to retain the services of such eligible persons and to provide incentives for such persons to exert maximum efforts for the success of SmartKem Limited. The Agreement commenced on the January 24, 2020 and the Agreement is administered by Board of Directors. The maximum aggregate number of shares of common shares which may be issued under all Awards granted to Participants under the Agreement shall be 15 % of SmartKem Limited’s issued capital shares. In the event of a termination of continuous service (other than as a result of a change of control, as defined in the Agreement), unvested share options generally shall terminate and, with regard to vested share options, the exercise period shall be the lesser of the original expiration date or six months from the date continuous service terminates. The Company has granted these share option awards to employees and consultants. Outstanding options generally expire 10 years after the grant date. Options are subject to vesting and, grantees become fully vested and exercisable when there is a liquidity event, such as a change in control or sale or admission (listing as a public company or initial public offering (“IPO”)), and the employee, or consultant, must be providing services to the Company at the time of the event. During the year ended December 31, 2020, the Company granted 1,828,128 SmartKem Limited share options to employees and consultants. These options were either exercised or cancelled as a result of the reverse merger and recapitalization. 70 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ On February 23, 2021, the Company approved the 2021 Equity Incentive Plan (“2021 Plan”), in which a maximum aggregate number of shares of common stock that may be issued under the 2021 Plan is 2,275,000 shares. Subject to the adjustment provisions of the 2021 Plan, the number of shares of the Company’s common stock available for issuance under the 2021 Plan will also include an annual increase on the first day of each fiscal year beginning with 2022 fiscal year and ending on the Company’s 2031 fiscal year in an amount equal to the least of: 1) 2,275,000 shares of the Company’s common stock; 2) four percent ( 4 %) of the outstanding shares of the Company’s common stock on the last day of the immediately preceding fiscal year; or 3) such number of shares of the Company’s common stock as the administrator may determine. As a result of the reverse merger and recapitalization, an aggregate of 402,586 options were issued during February 2021 under the 2021 Plan in consideration for the cancellation of the SmartKem Limited options that were outstanding. Of these options, 336,557 had an exercise price of $ 0.001 per share and 66,029 had an exercise price of $ 2.00 per share and all expire on the ten year anniversary of the grant date. These options were fully vested on the grant date. ​ During the year ended December 31, 2021, the Company has issued a further 1,707,326 options for employees, directors and consultants. The options vest over a period of four years , have an exercise price of $ 2.00 per share and expire on the ten year anniversary of the grant date. Determining the appropriate fair value of share-based awards requires the input of subjective assumptions, including the fair value of the Company’s common shares, and for share options, the expected life of the option, and expected share price volatility. The Company uses the Black-Scholes option pricing model to value its share option awards. The assumptions used in calculating the fair value of share-based awards represent management’s best estimates and involves inherent uncertainties and the application of management’s judgment. As a result, if factors change and management uses different assumptions, the share-based compensation expense could be materially different for future awards. Options granted under the 2021 Plan for year ended December 31, 2021 were valued using the Black-Scholes option-pricing model with the following assumptions: ​ ​ ​ ​ ​ ​ Year Ended ​ December 31, 2021 December 31, 2020 Expected term (years) 5 years - 6 years ​ 0.46 years Risk-free interest rate 0.3 % - 1.2 % ​ ( 0.7 %) - 0.2 % Expected volatility 54 % - 58 % ​ 58 % Expected dividend yield 0 % ​ 0 % ​ In the absence of a public trading market of the common share, on each grant date, the Company develops an estimate of the fair value of the common shares underlying the option grants. The Company estimated the fair value of the common shares by referencing arms-length transactions inclusive of the common shares underlying which occurred on or near the valuation date(s). From February 2022, the Company’s common shares are publicly traded and the Company will no longer have to estimate the fair value of the common share, rather the value will be determined based on quoted market prices. The Company determined the fair value of common share using methodologies, approaches and assumptions consistent with the AICPA Practice Guide, Valuation of Privately Held Company Equity Securities Issued as Compensation and based in part on input from an independent third-party valuation firm. The Company estimates its expected volatility by using a combination of historical share price volatilities of similar companies within our industry. The risk-free interest rate assumption is based on observed interest rates for the appropriate term of the Company’s options on a grant date. The expected option term assumption is the contractual term, as the service period is implied under the practical expedient since the Company does not have sufficient exercise history to estimate expected term of its historical option awards. 71 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ The following table reflects share activity under the share option plans for the years ended December 31, 2021 and 2020: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Weighted- ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Average ​ ​ ​ ​ ​ ​ ​ ​ ​ Weighted- ​ Remaining ​ Weighted- ​ Aggregate ​ ​ ​ ​ Average ​ Contractual ​ Average ​ Intrinsic ​ ​ Number of ​ Exercise ​ Term ​ Fair Value at ​ Value ​ ​ Shares ​ Price ​ (Years) ​ Grant Date ​ (in thousands) Options outstanding at January 1, 2020 ​ 160,317 ​ ​ 1.18311 ​ 7.31 ​ ​ 8.57245 ​ ​ ​ Exercised ​ — ​ ​ — ​ ​ ​ ​ ​ ​ ​ ​ Cancelled ​ ( 86,967 ) ​ ​ 0.65226 ​ ​ ​ ​ ​ ​ ​ ​ Forfeited ​ ( 90,729 ) ​ ​ 1.25578 ​ ​ ​ ​ ​ ​ ​ ​ Granted ​ 1,828,128 ​ ​ 0.05051 ​ ​ ​ ​ ​ ​ ​ ​ Options outstanding at December 31, 2020 1,810,749 ​ $ 0.06143 9.70 ​ $ 3.46867 ​ $ ​ Exercised ( 1,424,622 ) ​ 0.01447 ​ ​ ​ ​ Cancelled ( 405,936 ) ​ 0.06452 ​ ​ ​ ​ Forfeited ​ ( 136,221 ) ​ ​ 0.00100 ​ ​ ​ ​ ​ ​ ​ ​ Granted 2,109,912 ​ 1.68113 ​ ​ ​ ​ Options outstanding at December 31, 2021 1,953,882 ​ $ 1.72323 9.31 ​ $ 1.12355 ​ $ 465 Options exercisable at December 31, 2021 ​ 336,556 ​ $ 0.39318 ​ 9.15 ​ ​ ​ ​ $ 465 Vested and expected to vest after December 31, 2021 ​ 1,953,882 ​ $ 1.72323 ​ 9.31 ​ ​ ​ ​ $ 465 ​ The aggregate intrinsic value of options is calculated as the difference between the exercise price of the options and the fair value of our common shares at the end of the year for those options that had exercise prices lower than the fair value of our common shares. ​ The aggregate intrinsic value of options exercised during the years ended December 31, 2021 was $ 2.4 million. No options were exercised in the year end December 31, 2020. The total fair value of options vesting in the year to December 31, 2021 was $ 6.6 million. No options vested in the year to December 31, 2020. ​ The weighted-average grant-date fair value per share option granted for the year ended December 31, 2021 and 2020 was $ 1.14 . and $ 0.04 respectively. ​ Stock-based compensation, including stock options and warrants is included in the consolidated statements of operations as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ For the Year Ended December 31, ​ 2021 2020 Research and development ​ $ 2,982 ​ $ — Selling, general and administrative ​ 3,214 ​ — Total ​ $ 6,196 ​ $ — ​ As of December 31, 2021 there was $ 1.3 million of compensation cost related to non-vested stock option awards not yet recognized that will be recognized on a straight-line basis through the end of the vesting periods in September 2025. The amount of future stock option compensation expense could be affected by any future option grants or by any forfeitures. ​ ​ 72 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ ​ 12. INCOME TAXES United States and foreign loss from operations before income taxes was as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ For the Year Ended December 31, ​ 2021 2020 United States ​ $ ( 5,039 ) ​ $ — Foreign ​ ( 12,087 ) ​ ( 23,133 ) Loss before income taxes ​ $ ( 17,126 ) ​ $ ( 23,133 ) ​ A reconciliation of the statutory income tax rate to the Company’s effective tax rate consists of the following: ​ ​ ​ ​ ​ ​ ​ ​ ​ For the Year Ended December 31, ​ 2021 ​ 2020 Taxes at domestic rate ​ 21.0 % ​ 19.0 % Non-US statutory rates ​ ( 0.8 ) % ​ — % Permanent items ​ ( 7.3 ) % ​ ( 1.9 ) % Change in valuation allowance ​ ( 22.4 ) % ​ ( 9.4 ) % Loss on conversion of note and associated interest ​ — % ​ ( 8.4 ) % Statutory Rate Change ​ 9.6 % ​ — % Other ​ ( 0.1 ) % ​ 0.7 % Effective tax rate ​ — % ​ — % ​ Prior to the reorganization, domestic refers to UK tax jurisdiction and foreign refers to all non-UK tax jurisdictions. The components of income tax provision/(benefit) are as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ December 31, ​ 2021 2020 Current ​ ​ Federal ​ ​  — ​ ​  — State ​ ​ — ​ ​ — Foreign ​ ​ — ​ ​ — Total Current ​ $ — ​ $ — ​ ​ ​ ​ ​ ​ ​ Deferred ​ ​ ​ ​ Federal ​ ​  — ​ ​  — State ​ ​ — ​ ​ — Foreign ​ ​ — ​ ​ — Total Deferred ​ ​ — ​ ​ — Total ​ $ — ​ $ — ​ ​ 73 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ Deferred income taxes reflect the net tax effects of temporary differences between the carrying value of assets and liabilities for financial reporting purposes and amounts used for income tax purposes. The temporary differences that give rise to deferred tax assets and liabilities are as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ December 31, ​ 2021 2020 Deferred tax assets/(liabilities): ​ ​ ​ Net operating loss carryforwards ​ $ 7,506 ​ $ 3,931 Convertible notes payable discount and embedded derivative ​ — ​ — Property plant and equipment ​ ( 190 ) ​ ( 129 ) Other ​ 229 ​ 14 ​ ​ 7,545 ​ 3,816 Valuation allowance ​ ( 7,545 ) ​ ( 3,816 ) Deferred tax assets, net of allowance ​ $ — ​ $ — ​ The Company recorded a full valuation allowance against its net deferred tax assets as of December 31, 2021 and 2020. The Company considered the positive and negative evidence bearing upon its ability to realize the deferred tax assets. In addition to the Company’s history of cumulative losses, the Company cannot be certain that future taxable income will be sufficient to realize its deferred tax assets. Accordingly, a full valuation allowance has been provided against its net deferred tax assets. When the Company changes its determination as to the amount of its deferred tax assets that can be realized, the valuation allowance is adjusted with a corresponding impact to the provision for income taxes in the period in which such determination is made. As of December 31, 2021 and 2020, the Company had net operating loss carry-forwards of approximately $ 30,674 thousand and $ 20,691 thousand, respectively. The net operating loss carry-forwards were generated in the tax years from 2009 to 2021 with an unlimited carry-forward period. The Company has no uncertain tax positions, or penalties and interest accrued, that if recognized would reduce net operating loss carry-forwards or effect tax expense. The Company files tax returns as prescribed by the tax laws in the Unites States and United Kingdom in which they operate. In the normal course of business, the Company is subject to examination by the federal jurisdiction based on the statute of limitations. As of December 31, 2021, open years related to the United Kingdom are 2020 and 2019. The Company has no open tax audits with any taxing authority as of December 31, 2021. ​ ​ 13. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES: Selling, general and administrative expenses are comprised of the following items: ​ ​ ​ ​ ​ ​ ​ ​ ​ For the Years End December 31, ​ 2021 2020 Salaries and benefits ​ $ 5,366 ​ $ 908 Rent and property tax expense ​ 24 ​ 62 Insurance ​ ​ 486 ​ ​ — Utilities ​ 4 ​ 1 Sales and marketing ​ 749 ​ 96 Legal and professional fees ​ 1,132 ​ 625 Other selling, general, and administrative expenses ​ 308 ​ 15 Total ​ $ 8,069 ​ $ 1,707 ​ ​ 74 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ 14. DEFINED CONTRIBUTION PENSION: The Company operates a defined contribution pension scheme. The assets of the scheme are held separately from those of the Company in an independently administered fund. The pension cost charge represents contributions payable by the Company to the fund. Pension cost is included in the consolidated statements of operations as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ For the Years End December 31, ​ 2021 2020 Research and development ​ $ 98 ​ $ 83 Selling, general and administrative ​ 42 ​ 31 Total pension cost ​ $ 140 ​ $ 114 ​ As of December 31, 2021 and December 31, 2020 there were no amounts owed to the pension scheme. ​ 15. RELATED PARTY TRANSACTIONS: On May 14, 2020, the Company issued a promissory note (the “Note”) to a stockholder of the Company pursuant to which the Company agreed to repay the sum of any and all amounts advanced to the Company, on or before the date that the Company consummated a business combination with a private company or reverse takeover transaction or other transaction after which the Company would cease to be a shell company. The Note was non-interest bearing unless an event of default occurred. As of December 31, 2020, the amount due under the note payable was $ 20,000 . The maximum amount due under the note payable in the year ended December 31, 2021, was $ 47,500 which was repaid in full upon closing of the Exchange. ​ Prior to the closing of the Exchange, we used the office space and equipment of our management at no cost. ​ In addition to transactions and balances related share-based compensation to officers and directors, the Company incurred expenses of $ 65 thousand and $ 7 thousand, for the year ended December 31, 2021 and 2020, respectively, due to reimbursement of expenses and compensation for members of the Board of Directors. These expenses are recorded in selling, general & administrative in the consolidated statements of operations. As of December 31, 2021 and December 31, 2020, there was $ 18 thousand and zero , respectively, payable to members of the Board of Directors that are recorded in accounts payable and accrued expenses on the consolidated balance sheets. ​ During the year ended December 31, 2021, the Company reimbursed an owner for legal fees and other expenses as a result of the Exchange (see Note 1). The reimbursement of these fees for services resulted in an expense of $ 66 thousand for the year ended December 31, 2021 and there was zero payable as of December 31, 2021. ​ The Company obtained consulting services from an individual who is a family member of a Director of the Company. The consulting services resulted in an expense of $ 35 thousand for the year ended December 31, 2021 and there was zero payable as of December 31, 2021. ​ ​ ​ 75 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ ​ 16. SUBSEQUENT EVENTS: Under the adjustment provisions of the 2021 Plan, on January 1, 2022 the number of shares of the Company’s common stock available for issuance under the 2021 Plan was increased by 1,022,172 or four percent ( 4 %) of the total number of shares of Common Stock outstanding on December 31, 2021. After giving effect to the Evergreen Increase, the total number of shares of Common Stock that may be issued under Plan will be 3,297,172 . ​ On January 27, 2022, we sold 1,000,000 shares of our common stock at a purchase price of $ 2.00 per share to Octopus Investors in accordance with the Octopus Letter Agreement, dated as of February 23, 2021, among the Company and Octopus Titan VCT plc and certain related parties. ​ In February 2022, 12,500 shares of our common stock were issued to a vendor in consideration for services to be provided. ​ Quotations on our common stock on the OTC Market Group’s OTCQB® Market quotation system (“OTCQB”) commenced under the ticker symbol “SMTK” in February 2022. There was no trading of our common stock on the OTCQB or any other over-the-counter market prior to February 2022. ​ ​ ​ 76 Table of Contents ITEM 9 . Changes In And Disagreements With Accountants On Accounting And Financial Disclosure ​ None. ​