What changed in this filing

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Item 8. Financial Statements and Supplementary Data

2023-03-30 compared with 2022-03-28 · 218 added, 306 removed, 531 unchanged (50% of the section changed)

46 unchanged sentences

Cash and cash equivalents

Accounts receivable

Accounts receivable, net

Research and development tax credit receivable

1 unchanged sentence

Total current assets

Property, plant equipment, net of accumulated depreciation of $ 1,102 and $ 908

Property, plant and equipment, net

Right-of-use assets, net

Other assets, non-current

Liabilities and Stockholders' Equity

Current liabilities

Accounts payable and accrued expenses

Current lease liabilities

Lease liabilities, current

Income taxes payable

Other current liabilities

Total current liabilities

Non-current lease liabilities

Lease liabilities, non-current

Total liabilities

1 unchanged sentence

Stockholders’ Equity

Preferred stock, par value $ 0.0001 per share, 10,000,000 shares authorized, zero shares issued and outstanding, at December 31, 2022 and December 31, 2021, respectively

Common stock, par value $ 0.0001 per share, 300,000,000 shares authorized, 26,984,996 and 25,554,309 shares issued and outstanding , at December 31, 2022 and December 31, 2021, respectively

4 unchanged sentences

Total liabilities and stockholders’ equity

Please refer to Note 1

The accompanying notes are an integral part of these consolidated financial statements.

11 unchanged sentences

Total operating expenses

Loss from operations

Non-operating (Expense)/Income

Operating Loss

Non-operating income/(expense)

Loss on foreign currency transactions

1 unchanged sentence

Interest income

Change in fair value of derivative asset

Loss on conversion of convertible notes payable

Total non-operating expense

1 unchanged sentence

Income tax expense

Other comprehensive loss:

Foreign currency translation

Other comprehensive gain/(loss)

Foreign currency translation gain

Total comprehensive loss

6 unchanged sentences

(in thousands, except share data)

$0.0001 Par Value

Comprehensive

2 unchanged sentences

Balance at January 1, 2021

Issuance of common stock

Conversion of notes and interest

Issuance of common stock due to exercise of stock-options

Stock-based compensation expense

Repurchase of common stock

( 2,307,700 )

Effect of reverse capitalization

Issuance of common stock to vendor

Issuance of common stock and warrants in private placement

Issuance costs related to common stock and warrants in private placement

Foreign currency translation adjustment

Balance at December 31, 2021

$0.0001 Par Value

Comprehensive

2 unchanged sentences

Balance at January 1, 2022

Issuance of common shares due to exercise of stock-options

Stock-based compensation expense

Repurchase of common stock

( 2,307,700 )

Effect of reverse capitalization

Issuance of common shares to vendor

Issuance of common stock and warrants in private placement

Issuance costs related to common stock and warrants in private placement

Issuance of common stock to vendor

Issuance of common stock in private placement

Issuance costs related to common stock in private placement

Foreign currency translation adjustment

8 unchanged sentences

Adjustments to reconcile net loss to net cash used in operating activities:

Depreciation expense

Common shares issued to vendor for services

Amortization of right of use asset

Stock-based compensation

Non-cash interest expense

Change in fair value of embedded conversion feature

Loss on conversion of convertible notes payable

Change in operating assets and liabilities:

Stock option compensation expense

Loss on foreign currency transactions

Change in assets and liabilities:

Accounts receivable, net

3 unchanged sentences

Lease liabilities

Income taxes payable

Other current liabilities

Net cash used in operating activities

5 unchanged sentences

Repayment of term loan payable

Proceeds from the issuance of common stock

Proceeds from the issuance of common stock and warrants in private placement

Proceeds from the issuance of common stock in private placement

Payment of issuance costs

1 unchanged sentence

Net cash provided by financing activities

Effect of exchange rate changes on cash

Foreign currency effects on cash

Net change in cash

Cash, beginning of year

Cash, end of year

Cash and cash equivalents, beginning of year

Cash and cash equivalents, end of year

Supplemental disclosure of cash and non-cash investing and financing activities

Cash paid for income taxes

Cash paid for interest

1 unchanged sentence

Issuance of common shares for consulting services

Conversion of debt and accrued interest into common shares

The accompanying notes are an integral part of these consolidated financial statements.

2 unchanged sentences

Notes to Consolidated Financial Statements

BUSINESS AND LIQUIDITY

Organization & Reverse Recapitalization

20 unchanged sentences

Notes to Consolidated Financial Statements

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.

The Company is 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.

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

SmartKem’s 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.

The Company has a research and development facility in Manchester, UK, and manufactures product protypes for prospective customers using its semiconductor manufacturing processes housed at the Centre for Process Innovation (CPI) at Sedgefield, UK.

The Company has an extensive IP portfolio including over 125 issued patents across 19 patent families.

COVID-19 Pandemic

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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 additional costs incurred by the Company related to COVID-19 for the years ended December 31, 2022, and 2021, respectively 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 2023 and thereafter.

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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.

We have incurred recurring losses including net losses of $ 11.5 million and $ 17.1 million for the years ended December 31, 2022, and 2021, respectively.

As of December 31, 2022, we had an accumulated deficit of $ 86.6 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

We expect that our cash and cash equivalents of $ 4.2 million as of December 31, 2022, will be sufficient to fund our operating expenses and capital expenditure requirements through the end of May 2023.

It is possible this period could be shortened if there are any significant increases in planned spending or development programs or more rapid progress of development programs than anticipated.

SMARTKEM, INC.

1 unchanged sentence

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.

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, 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.

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.

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.

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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.

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.

Basis of Consolidation

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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

SMARTKEM, INC.

1 unchanged sentence

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.

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 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.

If the Company lost access to this fabrication facility, it would materially and adversely affect the Company’s ability to manufacture prototypes and demonstrate 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.

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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.

customer creditworthiness, past transaction history with the customer, current economic industry trends, and changes in customer payment terms.

These receivables have historically been paid timely.

12 unchanged sentences

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

Property, plant and equipment is depreciated over an estimated useful life of approximately 4 years .

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1 unchanged sentence

Notes to Consolidated Financial Statements

Impairment of Long-Lived Assets

Measurement of the amount of impairment would be based on generally accepted valuation methodologies, as deemed 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.

8 unchanged sentences

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.

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 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.

7 unchanged sentences

Inputs other than Level 1 prices for similar assets or liabilities that are directly or indirectly observable in the marketplace.

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

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1 unchanged sentence

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.

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, 2022, and 2021.

The carrying value of the 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.

Convertible Notes

5 unchanged sentences

The Company determined that all warrants meet the criteria to be classified as equity.

Non-retirement Post-employment Benefits

The company records employee severance benefits as non-retirement post-employment benefits that are accounted for under ASC 712-10.

A liability is accrued when it becomes probable that a payment will be made, and the amount is estimable.

In most cases, a payment is not deemed probable until the employer makes the decision to terminate the employee.

All severance payments identified were paid and expensed in the period incurred.

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, 2022 and 2021.

1 unchanged sentence

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.

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 of ASC 842 (January 1, 2019) in determining the present value of lease payments.

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.

The Company recognizes revenue under the core principle to depict the transfer of control to the Company’s customers in an amount reflecting the

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Notes to Consolidated Financial Statements

consideration the Company expects to be entitled to.

In order to achieve that core principle, the Company applies the following five step approach:

2 unchanged sentences

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 Company derives its revenues primarily from sales of TRUFLEX® inks and 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.

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Notes to Consolidated Financial Statements

does not have any significant financing components as payment is received at or shortly after the point of sale.

Revenue is recognized upon shipment of each TRULFEX® ink or demonstrator, at a point in time.

The Company 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.

Collaboration Arrangements

The company entered into several joint development agreements during the year.

The business arrangement between the two parties is not accounted for as a Collaborative Arrangement, as defined within the guidance under ASC 808, as both parties are not exposed to significant risks and rewards dependent on the commercial success of the activity.

It has also determined that other party is a vendor and not a customer, as defined within the guidance under ASC 606, as the other party did not primarily contract with SmartKem to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration.

It was SmartKem that contracted with the other party to obtain design services from it.

These agreements are accounted for under the guidance of ASC 705, Cost of Sales and Service.

Within ASC 705–20, Accounting for Consideration Received from a Vendor, the section discusses the accounting for consideration received by an entity from a vendor or supplier.

Consideration from a vendor includes cash amounts that an entity receives or expects to receive from a vendor (or from other parties that sell the goods or services to the vendor).

Consideration from a vendor also includes credit or other items (e.g., a coupon or voucher) that the entity can apply against amounts owed to the vendor (or to other parties that sell the goods or services to the vendor).

Consideration from a vendor should be accounted for as a reduction of the purchase price of the goods or services acquired from the vendor unless the consideration from the vendor is one of the following, a) in exchange for a distinct good or service;

b) a reimbursement of costs incurred by the entity to sell the vendor’s products;

or c) consideration for sales incentives offered to customers by manufacturers.

Research and Development Expenses

5 unchanged sentences

These costs are classified as research and development expenses in the accompanying consolidated statements of operations and comprehensive loss.

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Notes to Consolidated Financial Statements

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.

The Company’s 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.

Such incentives are recorded as other income when it is probable the amounts are collectible and can be reasonably estimated.

2 unchanged sentences

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;

Due to the absence of public trading market for the Company’s common stock before February 2022, 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 common stock on each grant date was estimated based upon a variety of factors, including:

● the issuance prices of shares of common stock;

● the rights and preferences of holders of preferred stock;

● the progress of the Company’s research and development programs;

4 unchanged sentences

● 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.

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Notes to Consolidated Financial Statements

● the likelihood of achieving a liquidity event, such as a securities offering, initial public offering or a sale of the Company’s common stock

From February 2022, the Company’s common stock is publicly traded, and the Company no longer has to estimate the fair value of the common stock, rather the value is determined based on quoted market prices.

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.

Shares of common stock are classified in stockholders’ equity and represent issued share capital.

Share-based compensation

3 unchanged sentences

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.

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

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Notes to Consolidated Financial Statements

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).

Non-cash stock-based compensation expense for the year ended December 31, 2022 and 2021were $ 0.5 million and $ 6.2 million, respectively (see also Note 10).

The estimated fair value of stock options at the grant date is determined using the Black-Scholes pricing model.

6 unchanged sentences

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 predecessor translated the consolidated financial statements into the presentation currency using exchange 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.

1 unchanged sentence

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.

Assets and liabilities of foreign operations 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.

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.

2 unchanged sentences

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, 2022 and 2021.

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.

As of December 31, 2022, and 2021, there were no material uncertain tax positions.

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1 unchanged sentence

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

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As of December 31, 2022, 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

Issuance 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, 2022, $ 170 thousand of offering costs were recorded in additional paid-in capital and 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, $ 1.3 million of direct and incremental costs associated with the Exchange were recorded as Transaction Expenses in the Consolidated Statement of Operations and Comprehensive Loss.

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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).

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Notes to Consolidated Financial Statements

The Company has 2,168,000 pre-funded common stock warrants outstanding as of December 31, 2022, which became exercisable on April 23, 2021 based on terms and conditions of the agreements.

1 unchanged sentence

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.

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Notes to Consolidated Financial Statements

The following potentially dilutive securities have been excluded from the computation of diluted weighted average shares outstanding as they would be anti-dilutive:

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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

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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 .

Securities Exchange filer.

However, the standard is not applicable until January 1, 2023, because the company has elected to apply the extended transition period available for emerging growth companies.

Emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies, which is effective prospectively for annual and interim periods beginning after December 15, 2022.

PREPAID EXPENSES AND OTHER CURRENT ASSETS:

Prepaid expenses and other current assets consist of the following:

Prepaid service charges and property taxes

Prepaid utilities

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VAT receivable

Other receivable and other prepaid expenses

Total prepaid expenses and other current assets

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.

As of December 31, 2022 and 2021, there was $ 169 thousand and $ 217 thousand, respectively, of non-current prepaid insurance related to directors’ and officers’ liability insurance that was included in the amounts above.

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Notes to Consolidated Financial Statements

PROPERTY, PLANT AND EQUIPMENT:

6 unchanged sentences

Depreciation expense was $ 198 thousand and $ 209 thousand for the year ended December 31, 2022 and 2021, respectively, and is classified as research and development expense.

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Notes to Consolidated Financial Statements

ACCOUNTS PAYABLE AND ACCRUED EXPENSES:

12 unchanged sentences

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:

SMARTKEM, INC.

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

The table below presents certain information related to the lease costs for the Company’s operating leases for the periods ended:

For the Year Ended December 31,

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Total lease cost

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:

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Supplemental non-cash amounts of operating lease liabilities arising from obtaining right of use assets

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,

Weighted average remaining lease term (in years) – operating leases

Weighted average discount rate – operating leases

SMARTKEM, INC.

1 unchanged sentence

Notes to Consolidated Financial Statements

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 leases as of the period ended:

For the Year Ended December 31,

Weighted average remaining lease term (in years) – operating leases

Weighted average discount rate – operating leases

Undiscounted operating lease liabilities as of December 31, 2022, by year and in the aggregate, having non-cancelable lease terms in excess of one year were as follows:

Total undiscounted lease payments

Less future minimum short-term lease payments

Less imputed interest

Total net lease liabilities

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,

Balance, beginning of year

Amortization of debt discount

Extinguishment of debt discount

Loss on conversion of note

Conversion of notes to equity

Foreign currency translation

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

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.

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

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:

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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.

For the year ended December 31, 2021, the Company incurred an effective interest rate of 26.20 % relating to notes payable.

The interest expense recognized based on the debt’s effective interest rate for the year ended December 31, 2022 and 2021, was zero and $ 19 thousand, 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.

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,

Balance, beginning of year

Loss on fair value of derivative asset included in earnings

Gain on extinguishment of derivative asset upon conversion

Foreign currency translation

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.

SMARTKEM, INC.

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

There were no notes payable outstanding at the years ended December 31, 2022 and 2021.

COMMITMENTS AND CONTINGENCIES:

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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.

SMARTKEM, INC.

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

Expenditure commitments contracted for but not yet incurred totaled $ 681 thousand and primarily consists of purchase commitments in the normal course of business for research & development services, communications infrastructure and administrative services.

STOCKHOLDERS’ EQUITY:

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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.

The Company has never paid any cash dividends to shareholders and do not anticipate paying any cash dividends to shareholders in the foreseeable future.

The Company has never paid any cash dividends to shareholders and does 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.

Our common stock is traded on the OTC Market Group’s OTCQB® Market (“OTCQB”) under the ticker symbol “SMTK”.

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 Company currently has no shares of preferred stock outstanding.

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.

SMARTKEM, INC.

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

Common Stock Warrants

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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.

During the years ended December 31, 2021 and December 31, 2022, 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.

SMARTKEM, INC.

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

A summary of the Company’s warrants to purchase common stock activity is as follows:

1 unchanged sentence

Forfeited or Expired

Warrants outstanding at January 1, 2022

Forfeited or Expired

Warrants outstanding at December 31, 2022

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.

During the years ended December 31, 2021, and December 31, 2022, 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 .

3 unchanged sentences

Forfeited or Expired

Pre-funded warrants outstanding at January 1, 2022

Forfeited or Expired

Pre-funded warrants outstanding at December 31, 2022

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:

December 31, 2021

Expected term (years)

Risk-free interest rate

Expected volatility

Expected dividend yield

There were no common stock warrants issued during the year ended December 31, 2020.

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.

There was no public trading market for our shares before February 2022 and the Company estimated its expected stock volatility based on historical volatility of publicly traded peer companies.

The Company did no t issue any warrants in the year ended December 31, 2022.

Common Stock Issued to Vendors for Services

On February 23, 2021, the Company issued 50,000 shares of common stock for advisory services.

On May 27, 2021, and November 29, 2021, the Company issued 25,000 and 12,500 shares of common stock, respectively, as payment for investor relations services.

SMARTKEM, INC.

1 unchanged sentence

Notes to Consolidated Financial Statements

On August 13, 2021, the company issued 60,000 shares of common stock for advisory services.

On February 28, 2022, May 27, 2022, and November 29, 2022, the Company issued 12,500 , 22,473 and 35,714 shares of common stock, respectively, as payment for investor relations services.

On June 29, 2022, the Company issued 360,000 shares of common stock as payment for a one-year internet advertising contract.

SHARE-BASED COMPENSATION:

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.

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or 3) such number of shares of the Company’s common stock as the administrator may determine.

As of January 1, 2021, there were 1,810,749 SmartKem Limited options that were outstanding.

Of these options 1,424,622 were accelerated and exercised by the holders thereof for a like number of ordinary shares of SmartKem Limited and exchanged for shares of the Company’s common stock pursuant to the Exchange.

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.

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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.

During the year ended December 31, 2022, the Company issued additional options exercisable for 918,000 shares of common stock to employees, directors and consultants.

The options vest over a period of three or 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.

2 unchanged sentences

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:

Options granted under the 2021 Plan for year ended December 31, 2022, and December 31, 2021, were valued using the Black-Scholes option-pricing model with the following assumptions:

December 31, 2022

2 unchanged sentences

6 years - 6.3 years

5 years - 6 years

Risk-free interest rate

3 unchanged sentences

Expected dividend yield

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.

Prior to February 2022, in the absence of a public trading market for the common stock, on each grant date, the Company developed an estimate of the fair value of the shares of common stock underlying the option grants.

SMARTKEM, INC.

1 unchanged sentence

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:

Company estimated the fair value of the shares of common stock by referencing arms-length transactions inclusive of the shares of common stock underlying which occurred on or near the valuation date(s).

The Company determined the fair value of the common stock 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.

From February 2022, the Company’s common stock is publicly traded, and the Company no longer has to estimate the fair value of the shares of common stock, rather the value is determined based on quoted market prices.

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 contractual term is 10 years , and the expected option term is lower.

The following table reflects share activity under the option plans for the years ended December 31, 2022, and 2021:

Fair Value at

1 unchanged sentence

Options outstanding at January 1, 2021

Options outstanding at December 31, 2020

( 1,424,622 )

Options outstanding at December 31, 2021

Options outstanding at December 31, 2022

Options exercisable at December 31, 2022

Vested and expected to vest after December 31, 2022

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.

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 stock at the end of the year for those options that had exercise prices lower than the fair value of our common stock.

No options were exercised in the year end December 31, 2022.

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 .

The aggregate intrinsic value of options exercised during the year ended December 31, 2021, was $ 2.4 million.

The total fair value of options vesting in the year ended December 31, 2022 was $ 690 thousand.

The total fair value of options vesting in the year ended December 31, 2021 was $ 6.6 million.

The weighted-average grant date fair value per option granted for the year ended December 31, 2022 and 2021 was $ 0.68 .

and $ 1.14 respectively.

Stock-based compensation, including stock options and warrants is included in the consolidated statements of operations as follows:

Stock-based compensation, including stock options is included in the consolidated statements of operations as follows:

SMARTKEM, INC.

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

For the Year Ended December 31,

1 unchanged sentence

Selling, general and administrative

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.

As of December 31, 2022, there was $ 1.4 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 July 2026.

The amount of future stock option compensation expense could be affected by any future option grants or by any forfeitures.

SMARTKEM, INC.

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

United States and foreign loss from operations before income taxes was as follows:

United States and foreign profit/(loss) from operations before income taxes was as follows:

For the Year Ended December 31,

2 unchanged sentences

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,

Year Ended December 31,

Taxes at domestic rate

State and local income taxes

Non-US statutory rates

1 unchanged sentence

Change in valuation allowance

Loss on conversion of note and associated interest

Statutory Rate Change

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:

Total Current

Total Deferred

SMARTKEM, INC.

1 unchanged sentence

Notes to Consolidated Financial Statements

The components of income tax provision/(benefit) are as follows:

Total Current

Total Deferred

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.

2 unchanged sentences

Net operating loss carryforwards

Convertible notes payable discount and embedded derivative

Property plant and equipment

6 unchanged sentences

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.

As of December 31, 2022, and 2021, the Company had net operating loss carry-forwards of approximately $ 39.5 million and $ 30.7 million, respectively.

The net operating loss carry-forwards were generated in the tax years from 2009 to 2022 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 has no uncertain tax positions, or penalties and interest accrued, that if recognized would reduce net operating loss carry-forwards or affect 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.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:

Selling, general and administrative expenses are comprised of the following items:

For the Years End December 31,

Salaries and benefits

Rent and property tax expense

Sales and marketing

Legal and professional fees

Other selling, general, and administrative expenses

As of December 31, 2022, open years related to the United States and United Kingdom are 2019 to 2021.

SMARTKEM, INC.

1 unchanged sentence

Notes to Consolidated Financial Statements

The Company has no open tax audits with any taxing authority as of December 31, 2022.

As of December 31, 2022, and December 31, 2021, the Company had no accrued interest and penalties related to uncertain tax positions and no amounts have been recognized in the Company’s statements of operations.

DEFINED CONTRIBUTION PENSION:

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Total pension cost

As of December 31, 2021 and December 31, 2020 there were no amounts owed to the pension scheme.

As of December 31, 2022, there was $ 1 thousand owed to the pension scheme that is recorded under accounts payable and accrued expenses on the consolidated balances sheets.

As of December 31, 2021, there were no amounts owed to the pension scheme.

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.

In addition to transactions and balances related to share-based compensation to officers and directors, the Company incurred expenses of $ 110 thousand and $ 65 thousand, for the year ended December 31, 2022 and 2021, 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.

As of December 31, 2022 and December 31, 2021, there was $ 16 thousand and $ 18 thousand, 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.

During the year ended 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.

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.

During the year ended December 31, 2022, the Company reimbursed an owner for legal fees and other expenses as a result of the Octopus Share Purchase.

The reimbursement of these fees for services resulted in an expense of $ 11 thousand for the year ended December 31, 2022 and there was zero payable as of December 31, 2022.

SUBSEQUENT EVENTS:

Under the evergreen adjustment provisions of the 2021 Plan, on January 1, 2023 the number of shares of the Company’s common stock available for issuance under the 2021 Plan was increased by 1,079,399 or four percent ( 4 %)

SMARTKEM, INC.

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Notes to Consolidated Financial Statements

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.

of the total number of shares of Common Stock outstanding on December 31, 2022.

After giving effect to increase, the total number of shares of Common Stock that may be issued under Plan will be 4,376,571 .

In January 2023, 50,000 shares of our common stock were issued to a vendor in consideration for services to be provided.

Changes In And Disagreements With Accountants On Accounting And Financial Disclosure

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 8. Financial Statements and Supplementary Data