What changed in this filing

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Item 7. Management’s Discussion and Analysis

2023-03-30 compared with 2022-03-28 · 80 added, 109 removed, 168 unchanged (53% of the section changed)

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Risk Factors” in this Report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statement.

We are 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.

Our semiconductor platform can be used in a number of applications including mini-LED displays, AMOLED displays, fingerprint sensors and logic circuits.

We develop our materials at our research and development facility in Manchester, UK, and at our semiconductor manufacturing process at the Centre of Process Innovation (CPI) in Sedgefield, UK.

We have an extensive IP portfolio including approximately 120 issued patents.

Since our inception in 2009, we have devoted substantial resources to the research and development of materials and production processes for the manufacture of organic thin film transistors and the enhancement of our intellectual property.

We are seeking to reshape the world of electronics with our proprietary organic semiconductor platform that we believe has the potential to affect the form and function of the next generation of low-cost displays and sensors.

Our patented TRUFLEX® inks are solution deposited at a low temperature, on low-cost substrates to make OTFT circuits.

Our organic semiconductor platform can be used in a number of applications including mini- and micro-LED displays, AMOLED displays, AR and VR headsets, fingerprint sensors and integrated logic circuits.

We have a research and development facility in Manchester, UK, and manufacture product protypes for prospective customers using our semiconductor manufacturing processes housed at the Centre for Process Innovation (CPI) at Sedgefield, UK.

We have an extensive IP portfolio including over 125 issued patents across 19 patent families.

Since our inception in 2009, we have devoted substantial amounts of our resources to the research and development of materials and production processes for the manufacture of organic thin film transistors and the enhancement of our intellectual property.

Our loss before income taxes was $11.5 million and $17.1 million for the year ended December 31, 2022, and 2021, respectively.

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Substantially all our operating losses have resulted from expenses incurred in connection with research and development activities and from general and administrative costs associated with our operations.

Recent Developments

Share Exchange (“the Exchange”)

On February 23, 2021, we entered into a Share Exchange Agreement (the “Exchange Agreement”) with SmartKem Limited (“SmartKem”), a private company incorporated under the Laws of England and Wales, and the former shareholders of SmartKem.

Pursuant to the Exchange Agreement, all of the equity interests in SmartKem, except certain “deferred shares” which had no economic or voting rights (“Deferred Shares”) and which were purchased by us for an aggregate purchase price of $1.40, were exchanged for shares of our common stock, par value $0.0001 per share (“common stock”), and SmartKem became our wholly owned subsidiary (the “Exchange”).

The Exchange was consummated on February 23, 2021.

As a result of the Exchange, we legally acquired the business of SmartKem and are continuing the existing business operations of SmartKem as a public reporting company under the name SmartKem, Inc.

The Exchange was treated as a recapitalization and reverse acquisition for us for financial reporting purposes, and SmartKem is considered the acquirer for accounting purposes.

As a result of the Exchange and the change in our business and operations, the historical financial results of SmartKem, the accounting acquirer, prior to the Exchange are considered our historical financial results.

At the closing of the Exchange (the “Closing”), each SmartKem ordinary share issued and outstanding immediately prior to the Closing (other than the Deferred Shares) was exchanged for 0.0111907 of a share of our common stock and each SmartKem A ordinary share issued and outstanding immediate prior to the Closing was exchanged for 0.0676668 of a share of our common stock, with the maximum number of shares of our common stock issuable to the former holders of SmartKem’s ordinary shares and A ordinary shares equal to 12,725,000.

This includes enterprise management incentive options to purchase 124,497,910 SmartKem ordinary shares (the “SmartKem 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 our common stock pursuant to the Exchange.

Immediately prior to the Closing, an aggregate of 2,500,000 shares of our common stock owned by our stockholders prior to the Exchange were forfeited and cancelled (the “Stock Forfeiture”).

In addition, pursuant to the Exchange Agreement and upon Closing, the unexercised non tax- advantaged options (the “SmartKem Unapproved Options”) to purchase SmartKem ordinary shares issued and outstanding were waived and released by the holders in consideration for new options to purchase such number of shares of our common stock equal to the number of shares of SmartKem ordinary shares subject to the relevant SmartKem Unapproved Option

immediately prior to the Exchange, multiplied by the applicable Exchange conversion ratio (which was equal to 0.0111907), with any fraction rounded to the nearest whole number.

The exercise price per share of each such new option is equal to the then-current exercise price of the relevant SmartKem Unapproved Option divided by the applicable Exchange conversion ratio (which was equal to 0.0111907) (rounded to the nearest one-tenth of one cent), except for new options issued to a U.S.

person which have an exercise price of $2.00 per share.

The new options were issued pursuant to our 2021 Equity Incentive Plan (the “2021 Plan”).

The new options replacing the SmartKem Unapproved Options cover an aggregate of 402,586 shares of our common stock, with options covering 336,557 shares of our common stock having an exercise price of $0.001 per share and the options covering the remaining 66,029 shares of our common stock having an exercise price of $2.00 per share.

Private Placement (“Offering”)

Following the Closing, on February 23, 2021, we sold 10,162,000 shares of our common stock and pre- funded warrants to purchase up to 2,168,000 shares of our common stock for aggregate gross proceeds of $24.6 million pursuant to a private placement offering of our common stock (or pre-funded warrants in lieu thereof) at a purchase price of $2.00 per share or $1.99 per pre-funded warrant, as applicable.

Pursuant to the offering, we offered to certain purchasers whose purchase of shares of our common stock in the offering would otherwise have resulted in the purchaser, together with its affiliates and certain related parties, beneficially owning more than 4.99% (or, at the election of the purchaser, 9.99%) of our outstanding common stock immediately following the closing of the offering, the opportunity to purchase, if any such purchaser so chose, pre-funded warrants in lieu of shares of our common stock that would otherwise have resulted in such purchaser’s beneficial ownership exceeding 4.99% (or, at the election of the purchaser, 9.99%) of our outstanding common stock, at a purchase price of $1.99 per pre-funded warrant.

Each pre-funded warrant is exercisable for one share of our common stock at an exercise price of $0.01 per share.

Octopus Share Purchase

On January 27, 2022, we sold an aggregate of 1,000,000 shares of our common stock at a purchase price of $2.00 per share to Octopus Titan VCT plc and Octopus Investments Nominees Limited in accordance with the Letter Agreement, dated as of February 23, 2021, between the Company and Octopus Titan VCT plc and certain related parties.

Key Factors Affecting Our Performance

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Protection of intellectual property is critical.

Therefore, steps such as additional patent applications, confidentiality and non-disclosure agreements, as well as other security measures are important.

Therefore, steps

such as additional patent applications, confidentiality, and non-disclosure agreements, as well as other security measures are important.

While we believe we have a strong patent portfolio and there is no actual or, to our knowledge, threatened litigation against us for patent-related matters, litigation or threatened litigation is a common method to effectively enforce or protect intellectual property rights.

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Components of Results of Operations

Our revenue currently consists of revenue from the sale of demonstration products.

Our revenue currently consists of revenue from the sale of TRUFLEX® inks and demonstration products.

Cost of Revenues.

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Other Operating Income.

Our other income includes government grants received for qualifying research and development projects, and research and development tax credits related to the United Kingdom’s Research and Development Expenditure Credit scheme, which is a government tax incentive designed to reward innovative companies for investing in research and development.

The income associated with these items are recognized in the period which the research and development expenses occurred.

Our Other Operating Income includes government grants received for qualifying research and development projects, and research and development tax credits related to the United Kingdom’s Research and Development tax relief for small and medium-sized enterprises, which is a government tax incentive designed to reward innovative companies for investing in research and development.

The income associated with these items is recognized in the period which the research and development expenses occurred.

Additionally, during the year ended December 31, 2021, the Company received government grants under the United Kingdom’s Coronavirus Job Retention Scheme.

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Interest Expense.

We issued convertible loans to a number of investors in 2018 and 2019.

These loans were all converted to equity in 2020.

The loans contained a beneficial conversion feature that resulted in a loan discount upon issue which was recognized as interest expense over the lifetime of the loan.

Upon conversion of the loans the remaining unamortized loan discount was recognized as interest expense in 2020.

We entered into a term loan facility agreement in 2021 and incurred interest charges on the amount drawn down.

The facility was repaid in full and there were no balances outstanding at December 31, 2022, and 2021.

Interest Income.

Interest income is interest on our cash deposits.

Other Income;

Other income is the gain or loss on remeasurement of lease liabilities

Change in Fair Value of Derivative Assets.

The convertible loans contained variable conversion price scenarios that were evaluated and determined to be derivatives that were bifurcated from the loan notes and accounted for separately.

The resulting derivative is accounted for at estimated market value with changes in the market value recorded in income.

Loss on Conversion of Convertible Notes Payable.

In January 2020 when the convertible loan notes were converted to A ordinary shares, a loss on conversion was recognized.

The loss represents the difference between the fair value of the A ordinary shares issued and the carrying value of the convertible loan notes plus accrued interest and the fair market value of the embedded derivative on the date of conversion.

Income Tax Expense.

Income tax expense consists primarily of income taxes in jurisdictions in which we conduct business.

We did not incur any income tax expense in 2021 or 2020.

We incurred income tax expense of $24 thousand in 2022 and zero in 2021.

Foreign Currency Translation.

Foreign currency translation reflect adjustments made due to currency fluctuations.

Foreign currency translation reflects adjustments made due to currency fluctuations.

Results of Operations

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Other operating income

Operating Expenses

Research and development

Selling, general and administrative

Research and development expenses

Selling, general and administrative expenses

Transaction expenses

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Revenue and Cost of Revenue

Our revenue currently consists of revenue from the sale of demonstration products.

The year on year change in revenue and gross profit reflects the one off nature of these sales, consistent with our current stage of commercialization.

Our revenue currently consists of revenue from the sale of TRUFLEX® inks and demonstration products.

The year-over-year change in revenue and gross profit reflects the largely one-off nature of these sales, consistent with our current stage of commercialization.

Other Operating Income

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Research & development grants

Sale of fixed assets

Total other operating income

Our Other Operating Income includes government grants received for qualifying research and development projects, and research and development tax credits related to the United Kingdom’s Research and Development Expenditure Credit (RDEC) scheme, which is a government tax incentive designed to reward innovative companies for investing in research and development.

The increase in RDEC Tax Credit reflects higher eligible expenditure in 2021 compared to 2020.

The increase in R&D Tax Credit reflects higher eligible expenditure in 2022

compared to 2021.

In 2021, R&D grant funding was secured for the “SmartLight” project that successfully demonstrated OTFT mini-LED backlights for displays with improved light uniformity and lower defects.

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Total operating expenses

Operating expenses increased by $11.6 million, or 192%, to $17.6 million for the year ended December 31, 2021, compared to $6.0 million for the comparable period of 2020.

The increase in Research and development expense was primarily due to stock-based compensation expense of $3.0 million in 2021 and from expenditure to further develop core materials and fabricate demonstrator devices to promote our technology to prospective customers and partners.

The increase in Selling, general and administrative expense was mainly due to $3.2 million stock-based compensation expense in 2021, from adding to our sales teams in the US and Asia and the strengthening of our finance team to prepare the Company’s US public company financial reporting, as well as from the additional legal, accounting and insurance expenses of operating as a public company.

Transaction costs of $1.3 million associated with the Exchange were incurred in the year ended December 31, 2021.

Operating expenses decreased by $6.7 million, or 38%, to $10.9 million for the year ended December 31, 2022, compared to $17.6 million for the comparable period of 2021.

Research and development expense, which represents 53% and 47% of our total operating expenses for the twelve months ended December 31, 2022 and 2021, respectively, decreased by $2.4 million to $5.8 million for the period, primarily due to a $2.7 million decrease in stock compensation expense, a $0.6 million reduction from the effect of exchange rate movement compared to the prior year, partially offset by a $0.9 million increase in expenses incurred in further developing core materials and in fabricating demonstrator devices to promote our technology to prospective customers and partners.

Selling, general and administrative expense, which represents 47% and 46% of our total operating expenses for the twelve months ended December 31, 2022 and 2021, respectively decreased by $3.0 million to $5.1 million for the period.

This decrease was mainly due to a $2.9 million decrease in stock compensation expense, a $0.3 million reduction from the effect of exchange rate movements compared to the prior period, partially offset by $0.2 million additional expense from the additional insurance and professional services expenses of operating as a public company and from increased marketing and related expenses promoting our products.

Transaction costs of $1.3 million associated with the Share Exchange Agreement with SmartKem Limited, pursuant to which all of the equity interests in SmartKem Limited, except certain “deferred shares” which had no economic or voting rights and which were purchased by us for an aggregate purchase price of $1.40, were exchanged for shares of our common stock and SmartKem Limited became our wholly owned subsidiary (the “Exchange”) were incurred in the year ended December 31, 2021.

The Exchange was consummated during the first quarter of 2021 and no significant additional Exchange-related expenses were recorded thereafter.

We expect to continue to incur significant expenses and operating losses for the foreseeable future.

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● increase activity directly related to promoting our products to increase revenues;

● add financial accounting and management systems to position us for growth and incur additional legal and accounting expense as we operate as a public company.

● add financial accounting and management systems to position us for growth.

Non-Operating (Expenses)/Income and Net Loss

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Interest income

Change in fair value of derivative asset

Loss on conversion of convertible notes payable

Total non-operating expense

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Income tax expense

The increase loss on foreign currency transactions in was due to fluctuations in U.S.

The increase in loss on foreign currency transactions was due to fluctuations in U.S.

pound value arising from transactions denominated in foreign currencies and the translation of foreign currency denominated balances on intra-group loans that were first advanced in 2021.

In the year ended December 31, 2020, the Company’s convertible loan notes were converted to equity following a qualifying event.

$6.8 million of Interest Expense resulted from recognition of unamortized loan discounts, $6.3 million of expense arose from change in the fair value of derivative assets that reflected the change in probability of conversion immediately before the conversion date and a $5.5 million loss on conversion of convertible notes payable arose from the difference between the fair value of the A ordinary shares issued and the carrying value of the convertible loan notes.

These expenses plus accrued interest and the fair market value of the embedded derivative on the date were all recorded as non-operating expenses.

For information regarding convertible notes and derivative assets, please refer to Notes 7 and 8 to our consolidated financial statements.

The loss before income taxes was $11.5 million for the year ended December 31, 2022, a decrease of $5.7 million, compared to a loss before income taxes of $17.1 million for the year ended December 31, 2021.

The decrease in loss was attributable to a reduction in non-operating losses resulting from the accounting recognition of loans converted to equity during 2020, partially offset by higher stock compensation expense, transaction costs from the Exchange in 2021 and operating expenses associated with being a public company.

The decrease in loss was attributable to lower stock compensation expense, the absence of transaction costs in 2022, partially offset by increases in loss on foreign currency transactions and lower operating expenses as described in the preceding paragraphs.

Liquidity and Capital Resources

Our future results are subject to substantial risks and uncertainties.

We have operated at a loss for our entire history and anticipate that losses will continue over the coming year.

To date, we have funded our liquidity and capital requirements primarily with proceeds from the private sale of our equity and debt securities and borrowing against our research and development credits.

As of December 31, 2021, our cash and cash equivalents were $12.2 million compared with $764 thousand as of December 31, 2020.

On January 27, 2022, we sold an aggregate of 1,000,000 shares of our common stock to existing investors at a price of $2.00 per share for total gross proceeds of $2.0 million.

For subsequent events, refer to Note 16 to our Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K.

We believe that our cash and cash equivalents will be sufficient to support our expected liquidity and working capital requirements for at least the next twelve months.

However, in the event that we enter into contracts involving significant sales of our products, development agreements, license agreements, collaborations, acquisitions or other material transactions, we may require additional working capital to support our increased obligations.

To date, we have

not recorded significant revenues related to product sales and therefore do not have any present need to fund inventory or accounts receivable.

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.

We will need to obtain additional funds to satisfy our operational needs and to fund our sales and marketing efforts, research and development expenditures, and business development activities.

Our future liquidity and working capital requirements will depend on many factors including our ability to generate revenue from product sales, the timing and extent of spending to support our sales and marketing, product development and research and development efforts, our entry into one or more material agreements containing significant performance obligations and our needs for working capital to support our business operations.

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We may be unable to raise additional funds or enter into such other agreements or arrangements when needed on favorable terms, or at all.

As of December 31, 2022, our cash and cash equivalents were $4.2 million compared with $12.2 million as of December 31, 2021.

We believe that our cash and cash equivalents will be sufficient to support our expected liquidity and working capital requirements through the end of May 2023.

To date, we have not recorded significant revenues related to product sales and therefore do not have any present need to fund inventory or accounts receivable.

Our consolidated financial statements as of December 31, 2022 have been prepared under the assumption that we will continue as a going concern for the next twelve months.

We expect to incur significant expenses and operating losses for the foreseeable future.

These factors raise substantial doubt about our ability to continue as a going concern.

Because our business does not generate positive cash flow from operating activities, we will need to obtain substantial additional capital in order to support our development efforts and fully commercialize our technology.

We believe we

will be able to raise additional capital in the event it is in our best interest to do so.

Management’s plans are to finance the working capital requirements through a combination of equity offerings, debt financings, collaborations, strategic alliances and marketing, distribution or licensing arrangements.

If we raise additional funds by issuing equity securities, our existing security holders will likely experience dilution.

If we borrow money, the incurrence of indebtedness would result in increased debt service obligations and could require us to agree to operating and financial covenants that could restrict our operations.

If we enter into a collaboration, strategic alliance or other similar arrangement, we may be forced to give up valuable rights.

To the extent additional capital is not available when needed or on acceptable terms, we may be forced to abandon some or all of our development and commercialization efforts, which would have a material adverse effect on the prospects of the business.

Further, our assumptions relating to our cash requirements may differ materially from our actual requirements because of a number of factors, including significant unforeseen delays, changes in timing, scope, focus and direction of our development efforts and costs related to commercialization.

The following table shows a summary of our cash flows for the years ended December 31, 2022 and 2021, respectively:

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Net cash provided by financing activities

Net change in cash

Effect of exchange rate changes on cash

Net change in cash

Cash, beginning of year

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Operating Activities

Net cash used in operating activities was $10.5 million for the year ended December 31, 2021, compared to $4.1 million for the year ended December 31, 2020, an increase of $6.4 million.

The increase resulted primarily from a decrease in our net loss of $6.0 million, offset by a decrease of non-cash expense of $12.0 million and an unfavorable movement in operating assets and liabilities of $0.4 million.

Net cash used in operating activities was $9.0 million for the year ended December 31, 2022, compared to $9.7 million for the year ended December 31, 2021, a decrease of $0.7 million.

The decrease resulted primarily from a decrease in our net loss of $5.6 million, partially offset by a decrease of non-cash expense of $4.6 million and a net decrease in operating assets and liabilities of $0.3 million.

Investing Activities

Net cash used in investing activities was $341 thousand for the year ended December 31, 2021, compared to $118 thousand for the year ended December 31, 2020, an increase of $223 thousand.

The increase resulted from a higher level of investment in laboratory and capital equipment purchases in 2021 to support our increased research and development activity.

Net cash used in investing activities was $79 thousand for the year ended December 31, 2021, compared to $0.3 million for the year ended December 31, 2021, a decrease of $0.2 million.

The decrease resulted from a reduced level of investment in laboratory and capital equipment purchases in 2022 after investment in these in previous years.

In the future, we expect to continue to incur capital expenditures to support our research and development activities and wider business operations.

Financing Activities

Net cash flows provided by financing activities was $22.2 million for the year ended December 31, 2021, compared to $4.6 million for the year ended December 31, 2020, an increase of $17.6 million.

The increase was due to the net proceeds of the Offering of $22.2 million, compared to $4.6 million from our 2020 private placement.

In January 2021, the Company entered into a term loan facility for $0.7 million acting as an advance of and secured against certain R&D tax credit amounts due.

The facility together with accrued interest of $19 thousand was repaid in full in March 2021.

Net cash flows provided by financing activities was $1.8 million for the year ended December 31, 2022, compared to $22.2 million for the year ended December 31, 2021, a decrease of $20.4 million.

During the first half of 2022, we consummated a private placement of our common stock resulting in net proceeds of $1.8 million.

In connection with the Exchange in February 2021, we consummated a private placement resulting in net cash of $22.2 million in the first half of 2021.

Contractual Payment Obligations

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Payments Due by Period

Operating lease obligations

Operating lease liabilities

Purchase obligations

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We recognize compensation expenses for the value of our equity awards granted based on the straight-line method over the requisite service period of each of the awards.

We periodically grant stock options for a fixed number of shares of common stock to our employees, directors, and non-employee contractors, with an exercise price greater than or equal to the fair market value of the common stock at the date of the grant.

We estimate the fair value of each stock option award using the Black-Scholes option-pricing model, which uses as inputs the fair value of our common stock and assumptions we make for the volatility of our common stock, the expected term of our stock-based awards, the risk-free interest rate for a period that approximates the expected term of our stock-based awards, and our expected dividend yield.

Estimates of fair value are not intended to predict actual future events or the value ultimately realized by persons who receive equity awards.

Prior to February 2022, the Company’s common stock was not traded on an over the counter or national securities exchange and consequently the Company developed estimates for the inputs to the option-pricing model.

We estimated the fair value of the shares of common stock by referencing arms-length transactions inclusive of the common shares underlying which occurred on or near the valuation date(s) or when these were not available, we 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.

We estimate our expected volatility based on the historical volatility of a set of our publicly traded peer companies.

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 for options granted in 2021 under the 2021 Plan 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.

The assumptions used in determining the fair value of stock-based awards represent our best estimates, but the estimates involve inherent uncertainties and the application of our judgment.

As a result, if factors change and we use significantly different assumptions or estimates, our stock-based compensation expense could be materially different in the future.

As a result, if factors change and we use

significantly different assumptions or estimates, our stock-based compensation expense could be materially different in the future.

Valuation allowance of deferred tax assets

Income taxes are recorded in accordance with ASC 740, Income Taxes (“ASC 740”), which provides for deferred taxes using an asset and liability approach.

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.

We recognize deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the consolidated financial statements or tax returns.

Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.

Valuation allowances are provided, if based upon the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.

We considered the positive and negative evidence bearing upon 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 at both December 31, 2021 and 2020.

Should the Company change its determination, based on the evidence available as to the amount of its deferred tax assets that can be realized, the valuation allowance will be adjusted with a corresponding impact to the provision for income taxes in the period in which such determination is made and which may be material.

Convertible Notes

SmartKem 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.

We considered the positive and negative evidence bearing upon our ability to realize the deferred tax assets.

In addition to our history of cumulative losses, we cannot be certain that future taxable income will be sufficient to realize our deferred tax assets.

Accordingly, a full valuation allowance has been provided against our net deferred tax assets at both December 31, 2022, and 2021.

Should we change our determination, based on the evidence available as to the amount of our deferred tax assets that can be realized, the valuation allowance will be adjusted with a corresponding impact to the provision for income taxes in the period in which such determination is made and which may be material.

Derivative Asset for Embedded Conversion Features

SmartKem does not use derivative instruments to hedge exposures to cash flow, market, or foreign currency risks.

SmartKem evaluates convertible notes to determine if those contracts or embedded components of those contracts qualify as derivatives to be accounted for separately.

We do not use derivative instruments to hedge exposures to cash flow, market, or foreign currency risks.

We evaluate convertible notes to determine if those contracts or embedded components of those contracts qualify as derivatives to be accounted for separately.

In circumstances where the embedded conversion option in a convertible instrument is required to be bifurcated and there are also other embedded derivative instruments in the convertible instrument that are required to be bifurcated, the bifurcated derivative instruments are accounted for as a single, compound derivative instrument.

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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 SmartKem 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.

The fair value of the embedded conversion features is estimated using a Monte Carlo simulation model, in which possible outcomes and their values are simulated repeatedly and randomly.

Under the Monte Carlo method we estimated the fair value of the convertible notes conversion feature at the time of issuance and subsequent remeasurement dates, utilizing the with-and without method, where the value of the derivative feature is the difference in values between a note simulated with the embedded conversion feature and the value of the same note simulated without the embedded conversion feature.

Estimating fair values of embedded conversion features requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors.

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We have experienced recurring losses since inception and expect to incur additional losses in the future in connection with research and development activities.

In the year ended December 31, 2021, we raised net proceeds of $22.2 million through the Offering and at December 31, 2021 we had $12.2 million of cash and cash equivalents after funding net cash used in operations for the year ended December 31, 2021 of $10.5 million.

We expect that our available cash balances will provide sufficient liquidity to fund our current obligations and projected working capital and capital expenditure requirements for at least the next 12 months from the issuance date of these consolidated financial statements through the first quarter of 2023.

Our management consider it is appropriate to continue to adopt the going concern basis in preparing the consolidated financial statements.

In the year ended December 31, 2022, we raised net proceeds of $1.8 million through the sale of our common stock.

and at December 31, 2022, we had $4.2 million of cash and cash equivalents after funding net cash used in operations for the year ended December 31, 2022, of $9.0 million.

Our future viability is dependent on our ability to raise additional capital to satisfy our operational needs and to fund our sales and marketing efforts, research and development expenditures, and business development activities.

Until such time, if ever, as we can generate sufficient cash through revenue, 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.

Until such time, if ever, as we can generate sufficient cash through revenue, management’s plans are to finance our working capital requirements through a combination of equity offerings, debt financings, collaborations, strategic alliances and marketing, distribution or licensing arrangements.

We may be unable to raise additional funds or enter into such other agreements or arrangements when needed on favorable terms, or at all.

There is substantial doubt that the Company will be able to pay its obligations as they fall due, and this substantial doubt is not alleviated by management plans.

The consolidated financial statements as of December 31, 2022 have been prepared assuming that the Company will continue as a going concern.

Accordingly, the consolidated financial statements do not include any adjustments to the amounts and classification of assets and liabilities that may be necessary should the Company be unable to continue as a going concern.

JOBS Act Accounting Election

We are an emerging growth company, as defined in the Jumpstart Our Business Startups Act, or the JOBS Act.

We are an emerging growth company, as defined in the JOBS Act.

The JOBS Act provides that an emerging growth company can take advantage of an extended transition period for complying with new or revised accounting standards.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis