SmartKem, Inc. 10-K

Item 8. Financial Statements and Supplementary Data ​ ​ ​ ​ ​ SmartKem, Inc. ​ ​ Index to Consolidated Financial Statements ​ ​ ​ Page ​ Report of Independent Registered Public Accounting Firm (BDO LLP: London, United Kingdom: PCAOB ID # 1295 ) 46 ​ Consolidated Balance Sheets as of December 31, 2022, and 2021 47 ​ Consolidated Statements of Operations and Comprehensive Loss for the years ended December 31, 2022, and 2021 48 ​ Consolidated Statements of Stockholders' Equity for the years ended December 31, 2022, and 2021 49 ​ Consolidated Statements of Cash Flows for the years ended December 31, 2022, and 2021 50 ​ Notes to the Consolidated Financial Statements 51 ​ ​ 45 Table of Contents Report of Independent Registered Public Accounting Firm ​ Shareholders and Board of Directors SmartKem, Inc. Manchester, United Kingdom Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of SmartKem, Inc. (the “Company”) as of December 31, 2022 and 2021, the related consolidated statements of operations and comprehensive loss, stockholders’ equity, and cash flows for each of the two years in the period ended December 31, 2022, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2022, in conformity with accounting principles generally accepted in the United States of America. Going Concern Uncertainty The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has suffered recurring losses from operations and has a net capital deficiency that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Basis for Opinion These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ BDO LLP BDO LLP We have served as the Company's auditor since 2020. Manchester, United Kingdom March 30, 2023 ​ 46 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Consolidated Balance Sheets (in thousands, except number of shares and per share data) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ December 31, ​ December 31, ​ 2022 2021 Assets ​ ​ Current assets ​ ​ Cash and cash equivalents ​ $ 4,235 ​ $ 12,226 Accounts receivable, net ​ 30 ​ — Research and development tax credit receivable ​ 1,121 ​ 1,070 Prepaid expenses and other current assets ​ 1,056 ​ 802 Total current assets ​ 6,442 ​ 14,098 Property, plant and equipment, net ​ 602 ​ 802 Right-of-use assets, net ​ 475 ​ 154 Other assets, non-current ​ 6 ​ 6 Total assets ​ $ 7,525 ​ $ 15,060 ​ ​ ​ ​ ​ ​ ​ Liabilities and Stockholders' Equity ​ ​ Current liabilities ​ ​ ​ ​ ​ ​ Accounts payable and accrued expenses ​ $ 931 ​ $ 1,423 Lease liabilities, current ​ 206 ​ 87 Income taxes payable ​ ​ 22 ​ — Other current liabilities ​ ​ 244 ​ — Total current liabilities ​ 1,403 ​ 1,510 Lease liabilities, non-current ​ 239 ​ 28 Total liabilities ​ 1,642 ​ 1,538 ​ ​ ​ ​ ​ ​ ​ Commitments and contingencies (Note 8) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ 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 ​ 3 ​ 3 Additional paid-in capital ​ 92,930 ​ 89,954 Accumulated other comprehensive loss ​ ( 483 ) ​ ( 1,363 ) Accumulated deficit ​ ( 86,567 ) ​ ( 75,072 ) Total stockholders’ equity ​ 5,883 ​ 13,522 Total liabilities and stockholders’ equity ​ $ 7,525 ​ $ 15,060 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ The accompanying notes are an integral part of these consolidated financial statements. ​ 47 Table of Contents ​ SMARTKEM, INC. AND SUBSIDIARIES Consolidated Statements of Operations and Comprehensive Loss (in thousands, except number of shares and per share data) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Year Ended December 31, ​ 2022 2021 Revenue ​ ​ $ 40 ​ $ 18 Cost of revenue ​ ​ 33 ​ 8 Gross profit ​ ​ 7 ​ 10 ​ ​ ​ ​ ​ ​ ​ ​ Other operating income ​ ​ 1,172 ​ 1,285 ​ ​ ​ ​ ​ ​ ​ ​ Operating expenses ​ ​ ​ Research and development ​ ​ 5,802 ​ 8,199 Selling, general and administrative ​ ​ 5,071 ​ 8,069 Transaction expenses ​ ​ — ​ 1,329 Total operating expenses ​ ​ 10,873 ​ 17,597 ​ ​ ​ ​ ​ ​ ​ ​ Operating Loss ​ ​ ( 9,694 ) ​ ( 16,302 ) ​ ​ ​ ​ ​ ​ ​ ​ Non-operating income/(expense) ​ ​ ​ Loss on foreign currency transactions ​ ​ ( 1,782 ) ​ ( 808 ) Interest expense ​ ​ — ​ ( 19 ) Interest income ​ ​ 5 ​ 3 Total non-operating expense ​ ​ ( 1,777 ) ​ ( 824 ) ​ ​ ​ ​ ​ ​ ​ ​ Loss before income taxes ​ ​ ( 11,471 ) ​ ( 17,126 ) Income tax expense ​ ​ ( 24 ) ​ — Net loss ​ ​ $ ( 11,495 ) ​ $ ( 17,126 ) ​ ​ ​ ​ ​ ​ ​ ​ Net loss ​ ​ $ ( 11,495 ) ​ $ ( 17,126 ) Other comprehensive gain/(loss) ​ ​ ​ Foreign currency translation gain ​ ​ 880 ​ 117 Total comprehensive loss ​ ​ $ ( 10,615 ) ​ $ ( 17,009 ) ​ ​ ​ ​ Basic & diluted net loss per common share ​ ​ $ ( 0.40 ) ​ $ ( 0.68 ) Basic & diluted weighted average shares outstanding ​ ​ ​ 28,861,789 ​ ​ 25,233,384 ​ ​ ​ ​ ​ The accompanying notes are an integral part of these consolidated financial statements. ​ ​ 48 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders’ Equity (in thousands, except share data) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Accumulated ​ ​ ​ ​ ​ ​ ​ Common stock ​ Additional ​ Other ​ ​ ​ ​ ​ ​ ​ ​ $0.0001 Par Value ​ Paid-in ​ Comprehensive ​ Accumulated ​ Stockholders’ ​ Shares Amount Capital Loss Deficit Equity (Deficit) Balance at January 1, 2021 13,627,887 ​ $ 1 ​ $ 61,276 ​ $ ( 1,480 ) ​ $ ( 57,946 ) ​ $ 1,851 Issuance of common stock due to exercise of stock-options ​ 1,424,622 ​ 1 ​ 19 ​ - ​ - ​ ​ 20 Stock-based compensation expense ​ - ​ - ​ 6,196 ​ - ​ - ​ ​ 6,196 Repurchase of common stock ​ ( 2,307,700 ) ​ - ​ - ​ - ​ - ​ ​ - Effect of reverse capitalization ​ 2,500,000 ​ - ​ - ​ - ​ - ​ ​ - Issuance of common stock to vendor ​ 147,500 ​ - ​ 280 ​ - ​ - ​ ​ 280 Issuance of common stock and warrants in private placement ​ 10,162,000 ​ 1 ​ 24,637 ​ - ​ - ​ ​ 24,638 Issuance costs related to common stock and warrants in private placement ​ - ​ - ​ ( 2,454 ) ​ - ​ - ​ ​ ( 2,454 ) Foreign currency translation adjustment ​ - ​ - ​ - ​ 117 ​ - ​ ​ 117 Net loss - ​ - ​ - ​ ​ ​ ( 17,126 ) ​ ( 17,126 ) Balance at December 31, 2021 ​ 25,554,309 ​ $ 3 ​ $ 89,954 ​ $ ( 1,363 ) ​ $ ( 75,072 ) ​ $ 13,522 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Accumulated ​ ​ ​ ​ ​ ​ ​ Common stock ​ Additional ​ Other ​ ​ ​ ​ ​ ​ ​ ​ $0.0001 Par Value ​ Paid-in ​ Comprehensive ​ Accumulated ​ Stockholders’ ​ Shares Amount Capital Loss Deficit Equity (Deficit) Balance at January 1, 2022 ​ 25,554,309 ​ $ 3 ​ $ 89,954 ​ $ ( 1,363 ) ​ $ ( 75,072 ) ​ $ 13,522 Stock-based compensation expense - ​ - ​ 488 ​ - ​ - ​ 488 Issuance of common stock to vendor 430,687 ​ - ​ 658 ​ - ​ - ​ 658 Issuance of common stock in private placement 1,000,000 ​ - ​ 2,000 ​ - ​ - ​ 2,000 Issuance costs related to common stock in private placement - ​ - ​ ( 170 ) ​ - ​ - ​ ( 170 ) Foreign currency translation adjustment - ​ - ​ - ​ 880 ​ - ​ 880 Net loss - ​ - ​ - ​ - ​ ( 11,495 ) ​ ( 11,495 ) Balance at December 31, 2022 ​ 26,984,996 ​ $ 3 ​ $ 92,930 ​ $ ( 483 ) ​ $ ( 86,567 ) ​ $ 5,883 ​ ​ ​ ​ ​ ​ The accompanying notes are an integral part of these consolidated financial statements. ​ ​ 49 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (in thousands) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Year Ended December 31, ​ ​ 2022 2021 ​ ​ ​ ​ ​ As restated Cash flows from operating activities: ​ ​ ​ Net loss ​ $ ( 11,495 ) ​ $ ( 17,126 ) Adjustments to reconcile net loss to net cash used in operating activities: ​ ​ Depreciation expense ​ 198 ​ 209 Common shares issued to vendor for services ​ 391 ​ 263 Amortization of right of use asset ​ 264 ​ 234 Stock option compensation expense ​ ​ 488 ​ ​ 6,196 Loss on foreign currency transactions ​ 1,782 ​ 808 Change in assets and liabilities: ​ ​ ​ ​ Accounts receivable, net ​ ( 32 ) ​ 19 Research & development tax credit receivable ​ ( 213 ) ​ ( 104 ) Prepaid expenses and other current assets ​ ( 42 ) ​ ( 532 ) Accounts payable and accrued expenses ​ ( 385 ) ​ 579 Lease liabilities ​ ( 265 ) ​ ( 276 ) Other assets ​ — ​ 2 Income taxes payable ​ 22 ​ — Other current liabilities ​ 238 ​ — Net cash used in operating activities ​ ( 9,049 ) ​ ( 9,728 ) ​ ​ ​ ​ ​ ​ ​ Cash flows from investing activities: ​ ​ Purchases of property, plant and equipment ​ ( 79 ) ​ ( 341 ) Net cash used by investing activities ​ ( 79 ) ​ ( 341 ) ​ ​ ​ ​ ​ ​ ​ Cash flows from financing activities: ​ ​ Proceeds from term loan payable ​ — ​ 738 Repayment of term loan payable ​ ​ — ​ ​ ( 738 ) Proceeds from the issuance of common stock and warrants in private placement ​ — ​ 24,638 Proceeds from the issuance of common stock in private placement ​ 2,000 ​ — Payment of issuance costs ​ ( 170 ) ​ ( 2,454 ) Proceeds from the exercise of stock options ​ — ​ 20 Net cash provided by financing activities ​ 1,830 ​ 22,204 ​ ​ ​ ​ ​ ​ ​ Foreign currency effects on cash ​ ( 693 ) ​ ( 673 ) ​ ​ ​ ​ ​ ​ ​ Net change in cash ​ ( 7,991 ) ​ 11,462 ​ ​ ​ ​ ​ ​ ​ Cash and cash equivalents, beginning of year ​ 12,226 ​ 764 Cash and cash equivalents, end of year ​ $ 4,235 ​ $ 12,226 ​ ​ ​ ​ ​ ​ ​ Supplemental disclosure of cash and non-cash investing and financing activities ​ ​ Cash paid for interest ​ $ — ​ $ 19 Right of use asset and lease liability additions ​ $ 583 ​ $ 136 Issuance of common shares for consulting services ​ $ 633 ​ $ 256 ​ ​ ​ ​ The accompanying notes are an integral part of these consolidated financial statements. ​ ​ 50 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ 1. BUSINESS Organization & Reverse Recapitalization SmartKem, Inc. (“SmartKem” or the “Company”) a Delaware corporation, formerly known as Parasol Investments Corporation (“Parasol”), was formed on May 13, 2020, and is the successor, as discussed below, of SmartKem Limited, which was formed under the Laws of England and Wales. The Company was founded as a “shell” company registered under the Exchange Act, with no specific business plan or purpose until it began operating the business of SmartKem Limited following the closing of the Exchange described below. On February 23, 2021, Parasol entered into a Securities Exchange Agreement (“the Exchange Agreement”), with SmartKem Limited. Pursuant to the Exchange Agreement all of the equity interests in SmartKem Limited, except certain deferred shares which had no economic or voting rights (the “Deferred Shares”) and which were purchased by Parasol for an aggregate purchase price of $ 1.40 , were exchanged for shares of Parasol common stock, par value $ 0.0001 per share (“common stock”), and SmartKem Limited became a wholly owned subsidiary of Parasol (the “Exchange”). ​ As a result of the Exchange, Parasol legally acquired the business of SmartKem Limited, and continues as the existing business operations of SmartKem Limited as a public reporting company under the name SmartKem, Inc. ​ Under ASC 805, Business Combinations, SmartKem Limited was deemed the accounting acquirer based on the following predominate factors: Parasol was created as a “shell” company to effect a business combination and had no operations, the former shareholders of SmartKem Limited own more than a majority of the outstanding voting stock of the Company, the Company’s board of directors and management consists of the former board of directors and management of SmartKem Limited, SmartKem Limited was the largest entity by assets at the time of the Exchange, and the principal operating location of the Company is SmartKem Limited’s premises which are located in Manchester, United Kingdom. ​ The Exchange was accounted for as a reverse recapitalization, with no goodwill or other intangible assets recorded, in accordance with accounting principles generally accepted in the United States of America (“US GAAP”). Under this method of accounting, Parasol was treated as the “acquired” company for financial reporting purposes. Accordingly, for accounting purposes, the Exchange was treated as the equivalent of SmartKem Limited issuing stock for the net assets of Parasol, accompanied by a recapitalization. The net assets of Parasol are stated at historical cost, with no goodwill or other intangible assets recorded. The consolidated assets, liabilities, and results of operations prior to the Exchange are those of SmartKem Limited. Reported shares and earnings per share available to holders of the Company’s common stock, prior to the Exchange, have been retroactively restated as shares reflecting the exchange ratios established in the Exchange. ​ At the closing of the Exchange (the “Closing”), each SmartKem Limited ordinary share issued and outstanding immediately prior to the Closing (other than the Deferred Shares) was exchanged for 0.0111907 of a share of the Company’s common stock and each SmartKem Limited A ordinary share issued and outstanding immediately prior to the Closing was exchanged for 0.0676668 of a share of the Company’s common stock, with the maximum number of shares of our common stock issuable to the former holders of SmartKem Limited’s ordinary shares and A ordinary shares equal to 12,725,000 . This includes enterprise management incentive options to purchase 124,497,910 SmartKem Limited ordinary shares (the “SmartKem Limited EMI Options”) issued and outstanding immediately prior to the Closing that were accelerated and exercised by the holders thereof for a like number of ordinary shares and exchanged for shares of the Company’s common stock pursuant to the Exchange. In aggregate 1,127,720,477 SmartKem Ltd shares were exchanged for 12,725,000 of the Company’s common stock, an average exchange ratio of 0.011283825 . Immediately prior to the Closing, an aggregate of 2,500,000 shares of the Company’s common stock owned by the stockholders of Parasol prior to the Exchange were forfeited and cancelled (the “Stock Forfeiture”). ​ 51 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ Business 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 In March 2020, the World Health Organization declared the outbreak of COVID-19 as a global pandemic (the “Pandemic”). The Pandemic has had a widespread and detrimental effect on the global economy and has adversely impacted the Company’s business and results of operations. The Company has experienced travel bans, states of emergency, quarantines, lockdowns, “shelter in place” orders, business restrictions and shutdowns in the countries where it operates. The Company’s containment measures have impacted its day-to-day operations and disrupted its business. Because the severity, magnitude and duration of the Pandemic and its economic consequences are highly uncertain, rapidly changing and difficult to predict, the ultimate impact of the Pandemic on the Company’s business, financial condition and results of operations is currently unknown. The additional costs incurred by the Company related to COVID-19 for the 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. These costs are not expected to be material. The consolidated entity presented is referred to herein as “SmartKem”, “we”, “us”, “our”, or the “Company”, as the context requires and unless otherwise noted. ​ 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Basis for Presentation These consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission and accounting principles generally accepted in the United States of America (“US GAAP”) as defined by the Financial Accounting Standards Board (FASB) within the FASB Accounting Standards Codification (“ASC”) and are presented in thousands, except number of shares and per share data. Going Concern The accompanying consolidated financial statements have been prepared on the basis of continuity of operations, realization of assets and the satisfaction of liabilities, and commitments in the ordinary course of business. 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 $ 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. 52 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ Our future viability is dependent on our ability to raise additional capital to fund our operations. 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. The precise amount and timing of the funding needs cannot be determined accurately at this time, and will depend on a number of factors, including the market demand for the Company’s products and services, the quality of product development efforts, management of working capital, and continuation of normal payment terms and conditions for purchase of services. If the Company is unable to substantially increase revenues, reduce expenditures, or otherwise generate cash flows for operations, then the Company will need to raise additional funding to continue as a going concern. 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 The consolidated financial statements include the accounts of SmartKem, Inc. and its wholly-owned subsidiaries, SmartKem Delaware, Inc. and SmartKem Limited. The Company does not have any nonconsolidated subsidiaries. All intercompany balances and transactions have been eliminated on consolidation, including unrealized gains and losses on transactions between the companies. The Company's formerly wholly owned subsidiary, SmartKem Delaware Inc. was dissolved on May 13, 2021. Comprehensive loss Comprehensive loss of all periods presented is comprised primarily of net loss and foreign currency translation adjustments. Management’s Use of Estimates The preparation of consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, including disclosure of contingent assets and liabilities, at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. The most significant estimates in the Company’s consolidated financial statements relates to the valuation of common share, fair value of share options, fair value of embedded conversion features in the convertible notes, and the valuation allowance of deferred tax assets. These estimates and assumptions are based on current facts, historical experience and various other factors believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of expenses that are not readily apparent from other sources. Due to the uncertainty of factors surrounding the estimates or judgments used in the preparation of the consolidated financial statements, actual results may materially vary from these estimates. 53 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ 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 technology, and compliance with regulatory requirements. 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 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. Alternative providers of similar services exist, but would take effort and time to bring into the Company’s operations. Cash and Cash Equivalents The Company considers all highly liquid investments purchased with original maturities of 90 days or less at acquisition to be cash equivalents. As of December 31, 2022 and 2021, the Company did no t have any cash equivalents. Accounts Receivable Accounts receivable are stated at the amount the Company expects to collect and do not bear interest. The Company considers the following factors when determining the collectability of specific customer accounts: customer creditworthiness, past transaction history with the customer, current economic industry trends, and changes in customer payment terms. These receivables have historically been paid timely. Due to the nature of the accounts receivable balance, the Company believes there is no significant risk of non-collection. If the financial condition of the Company’s customers were to deteriorate, adversely affecting their ability to make payments, allowances for doubtful accounts would be required. There was no allowance for doubtful accounts recorded as of December 31, 2022, and 2021. Concentrations of Credit Risk Financial instruments that potentially subject the Company to significant concentration of credit risk consist primarily of cash and cash equivalents and accounts receivable. Periodically, the Company maintains deposits in financial institutions in excess of government insured limits. Management believes that the Company is not exposed to significant credit risk as the Company’s deposits are held at financial institutions that management believes to be of high credit quality and the Company has not experienced any losses in these deposits. Property, Plant and Equipment Property, plant and equipment is stated at cost, less accumulated depreciation. Maintenance and repairs are expensed when incurred. Additions and improvements that extend the economic useful life of the asset are capitalized and depreciated over the remaining useful lives of the assets. The cost and accumulated depreciation of assets sold or retired are removed from the respective accounts, and any resulting gain or loss is reflected in current earnings. Depreciation and amortization are provided using the accelerated declining balance method in amounts considered to be sufficient to amortize the cost of the assets to operations over their estimated useful lives. Property, plant and equipment is depreciated over an estimated useful life of approximately 4 years . 54 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ 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 appropriate. If the carrying amount is greater than the undiscounted cash flows, the carrying amount of the asset is reduced to the asset’s fair value. An impairment loss is recognized immediately as an operating expense in the consolidated statements of operations. Reversal of previously recorded impairment losses are prohibited. As of December 31, 2022, and 2021, Company’s management believed that no revision to the remaining useful lives or impairment of the Company’s long-lived assets was required. Derivative Asset for Embedded Conversion Features The Company does not use derivative instruments to hedge exposures to cash flow, market, or foreign currency risks. The Company evaluates convertible notes to determine if those contracts or embedded components of those contracts qualify as derivatives to be accounted for separately. In circumstances where the embedded conversion option in a convertible instrument is required to be bifurcated and there are also other embedded derivative instruments in the convertible instrument that are required to be bifurcated, the bifurcated derivative instruments are accounted for as a single, compound derivative instrument. The result of this accounting treatment is that the fair value of the embedded derivative is recorded as a liability and marked-to-market each balance sheet date, with the change in fair value recorded in the statements of operations as other income or expense. Upon conversion or exercise of a derivative instrument, the instrument is marked to fair value at the conversion date and then that fair value is reclassified to equity. The fair value of the embedded conversion features 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. Estimating fair values of embedded conversion features requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. Fair Value of Financial Instruments ​ ASC 820, Fair Value Measurements , provides guidance on the development and disclosure of fair value measurements. Under this accounting guidance, fair value is defined as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. ​ The accounting guidance classifies fair value measurements in one of the following three categories for disclosure purposes: ​ Level 1: Quoted prices in active markets for identical assets or liabilities. ​ Level 2: Inputs other than Level 1 prices for similar assets or liabilities that are directly or indirectly observable in the marketplace. 55 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ ​ Level 3: Unobservable inputs which are supported by little, or no market activity and values determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant judgment or estimation. ​ Fair value measurements discussed herein are based upon certain market assumptions and pertinent information available to management as of and during the years ended December 31, 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 The Company accounts for its convertible notes in accordance with ASC 470-20, Debt with Conversion and Other Options (“ASC 470-20”), which requires the liability and equity components of convertible debt instruments to be separately accounted for in a manner that reflects the issuer’s nonconvertible debt borrowing rate. Debt discount created by the bifurcation of embedded feature in the convertible notes are reflected as a reduction to the related debt liability. The discount is amortized to interest expense over the term of the debt using the effective-interest method. Warrants The accounting treatment of warrants issued is determined pursuant to the guidance provided by ASC 480, Distinguishing Liabilities from Equity , and ASC 815, Derivatives and Hedging , as applicable. Each feature of a freestanding financial instrument including, without limitation, any rights relating to subsequent dilutive issuance, dividend issuances, equity sales, rights offerings, forced conversions, dividends, and exercise are assessed with determinations made regarding the proper classification in the Company’s consolidated financial statements. The Company determined that all warrants meet the criteria to be classified as equity. 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. Leases Operating lease assets are included within operating lease right-of-use assets, and the corresponding operating lease obligation on the consolidated balance sheets as of December 31, 2022 and 2021. The Company has elected not to present short-term leases as these leases have a lease term of 12 months or less at lease inception and do not contain purchase options or renewal terms that the Company is reasonably certain to exercise. All other lease assets and lease liabilities are recognized based on the present value of lease payments over the lease term at commencement date. Because most of the Company’s leases do not provide an implicit rate of return, the Company used an incremental borrowing rate based on the information available at adoption date of ASC 842 (January 1, 2019) in determining the present value of lease payments. Revenue The Company applies the provisions of ASC 606, Revenue from Contracts with Customers . The Company recognizes revenue under the core principle to depict the transfer of control to the Company’s customers in an amount reflecting the 56 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES 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: (1) identify the contract with a customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contact and (5) recognize revenue when a performance obligation is satisfied. The Company’s current contracts with customers do not contain significant estimates or judgments. All of the Company’s revenue contains a single performance obligation that is recognized upon fulfilment of the sales order. The Company derives its revenues primarily from sales of 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 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 The Company expenses research and development costs as incurred. Research and development costs include salaries, employee benefit costs, direct project costs, supplies and other related costs. Advance payments for goods and services that will be used in future research and development activities are expensed when the activity has been performed or when the goods have been received. Patent and Licensing Costs Patent and licensing costs are expensed as incurred because their realization is uncertain. These costs are classified as research and development expenses in the accompanying consolidated statements of operations and comprehensive loss. 57 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ Other Operating Income 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. For the year ended December 31, 2022 and 2021, the Company recorded grant income and research & development tax credits of $ 1,172 thousand and $ 1,285 thousand, respectively, which are recorded as other operating income in the accompanying consolidated statements of operations. As of December 31, 2022, and December 31, 2021, the Company had receivables related to research & development tax credits for payments not yet received of $ 1,121 thousand and $ 1,070 thousand, respectively. Ordinary Shares Valuation ​ 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; ● the Company’s stage of development and business strategy; ● external market conditions affecting the technology industry and trends within the technology industry; ● the Company’s financial position, including cash on hand; ● the Company’s historical and forecasted performance and operating results; ● the lack of active public market for the Company’s ordinary shares; ● the likelihood of achieving a liquidity event, such as a securities offering, initial public offering or a sale of the Company’s 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. ​ Shares of common stock are classified in stockholders’ equity and represent issued share capital. Share-based compensation All share-based payments, including grants of stock options, are measured based on the fair value of the share-based awards at the grant date and recognized over their respective vesting periods. Outstanding options generally expire 10 years after the grant date. The Company has issued options that vest based on service requirements and issued options that vest based on performance requirements. Options become exercisable when service requirements are met. In the case of performance-based options, options become exercisable when there is a liquidity event, such as a change in control or sale or admission (listing as a public company or initial public offering (“IPO”)), and the employee, or consultant, must be 58 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES 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, 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. The Black-Scholes option pricing model requires inputs such as the fair value of common stock on date of grant, expected term, expected volatility, dividend yield, and risk-free interest rate. The assumptions used in calculating the fair value of stock-based awards represent management’s best estimates and involve inherent uncertainties and the application of management’s judgment. As a result, if factors change and management uses different assumptions, stock-based compensation expense could be materially different for future awards. The Company records forfeitures when they occur. Functional Currency and Operations Prior to the Exchange, SmartKem Limited’s (“the predecessor’s”) functional currency was the British Pound Sterling (“GBP”), and the consolidated financial statements were presented in United States dollars (“USD”). The predecessor’s functional currency was the respective local currency of the primary economic environment in which an entity’s operations are conducted. The predecessor translated the consolidated financial statements into the presentation currency using 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. dollar (“USD”). The functional currency of the Company’s foreign operation is the respective local currency. 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. Income Taxes 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. 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, 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. 59 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ Contingent Liabilities A provision for contingent liabilities is recorded when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. With respect to legal matters, provisions are reviewed and adjusted to reflect the impact of negotiations, estimated settlements, legal rulings, advice of legal counsel and other information and events pertaining to a particular matter. The Company is a party to certain litigation and disputes arising in the normal course of business. As of December 31, 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. 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. 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. Segment Information The Company has determined that it operates and reports in one segment , which focuses on the development of materials and processes used to make organic thin-film transistors (OTFTs) for the manufacture of flexible electronics. The Company’s operating segment is reported in a manner consistent with the internal reporting provided to the chief operating decision maker (“CODM”). The Company’s CODM has been identified as its Chairman and Chief Executive Officer. Basic and Diluted Loss Per Share Basic and diluted net loss per share is determined by dividing net loss by the weighted average ordinary shares outstanding during the period. For all periods presented with a net loss, the shares underlying the ordinary share options and warrants have been excluded from the calculation because their effect would be anti-dilutive. Therefore, the weighted-average shares outstanding used to calculate both basic and diluted loss per share are the same for periods with a net loss. ​ The loss per share information in these consolidated financial statements is reflected and calculated as if the Company had existed since January 1, 2021. 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). 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. As the pre-funded common stock warrants are exercisable for $ 0.01 , these shares are considered outstanding common shares and included in computation of basic and diluted Earnings Per Share as the exercise of the pre-funded common stock warrants is virtually assured. The Company included these pre-funded common stock warrants in basic and diluted earnings per share when all conditions were met on April 23, 2021. ​ 60 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES 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: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ December 31, ​ 2022 2021 Options ​ ​ 2,829,756 ​ ​ 1,953,882 Warrants ​ 985,533 ​ 985,533 Total ​ ​ 3,815,289 ​ ​ 2,939,415 ​ Recent Accounting Pronouncements In June 2016, the FASB issued Accounting Standards Update (“ASU”) No. 2016-13, Financial Instruments: Credit Losses (Topic 326) , which requires measurement and recognition of expected losses for financial assets held. The new standard changes the impairment model for most financial instruments, including trade receivables, from an incurred loss method to a new forward-looking approach, based on expected losses. The estimate of expected credit losses will require organizations to incorporate considerations of historical information, current conditions and reasonable and supportable forecasts. The standards update is effective prospectively for annual and interim periods in fiscal years beginning after December 15, 2019, with early adoption permitted, for U.S. Securities Exchange filer. 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. 3. PREPAID EXPENSES AND OTHER CURRENT ASSETS: Prepaid expenses and other current assets consist of the following: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ December 31, ​ December 31, ​ 2022 2021 Prepaid service charges and property taxes ​ $ 55 ​ $ 58 Prepaid utilities ​ 51 ​ 51 Prepaid insurance ​ 358 ​ 412 Prepaid administrative expenses ​ 35 ​ 63 Prepaid technical fees ​ ​ 22 ​ ​ 141 Prepaid consulting fees ​ ​ 304 ​ ​ 27 VAT receivable ​ 195 ​ 50 Other receivable and other prepaid expenses ​ ​ 36 ​ ​ — Total prepaid expenses and other current assets ​ $ 1,056 ​ $ 802 ​ ​ 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. ​ ​ ​ 61 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ 4. PROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment consist of the following: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ December 31, ​ December 31, ​ 2022 2021 Plant and equipment ​ $ 1,478 ​ $ 1,633 Furniture and fixtures ​ 218 ​ 245 Computer hardware and software ​ 24 ​ 26 ​ ​ 1,720 ​ 1,904 Less: Accumulated depreciation ​ ( 1,118 ) ​ ( 1,102 ) Property, plant and equipment, net ​ $ 602 ​ $ 802 ​ 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. ​ ​ 5. ACCOUNTS PAYABLE AND ACCRUED EXPENSES: Accounts payable and accrued expenses consist of the following: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ December 31, ​ December 31, ​ 2022 2021 Accounts payable ​ $ 230 ​ $ 510 Accrued expenses – lab refurbishments ​ 117 ​ 131 Accrued expenses – technical fees ​ 130 ​ 66 Accrued expenses – variable rent & utilities ​ 15 ​ 20 Accrued expenses – audit & accounting fees ​ 128 ​ 191 Accrued expenses – other ​ 80 ​ 112 Credit card liabilities ​ 20 ​ 10 Payroll and social security liabilities ​ 211 ​ 383 Total accounts payable and accrued expenses ​ $ 931 ​ $ 1,423 ​ ​ 6. LEASES: The Company has operating leases consisting of office space, lab space, and equipment with remaining lease terms of 1 to 3 years , subject to certain renewal options as applicable. There was no sublease rental income for the year ended December 31, 2022 and 2021. The Company is not the lessor in any lease agreement, and no related party transactions for lease arrangements have occurred. ​ 62 Table of Contents 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, ​ 2022 2021 Operating lease cost ​ $ 262 ​ $ 225 Short-term lease cost ​ 10 ​ 32 Variable lease cost ​ 186 ​ 140 Total lease cost ​ $ 458 ​ $ 397 ​ The total lease cost is included in the consolidated statements of operations as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ For the Year Ended December 31, ​ ​ 2022 2021 Research and development ​ $ 430 ​ $ 373 Selling, general and administrative ​ 28 ​ 24 Total lease cost ​ $ 458 ​ $ 397 ​ ​ Right of use lease assets and lease liabilities for our operating leases were recorded in the consolidated balance sheets as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ December 31, ​ December 31, ​ 2022 2021 Assets ​ ​ ​ Operating lease right of use assets ​ $ 475 ​ $ 154 Total lease assets ​ $ 475 ​ $ 154 Liabilities ​ ​ Current liabilities: ​ ​ Operating lease liability – current portion ​ $ 206 ​ $ 87 Noncurrent liabilities: ​ ​ ​ Operating lease liability, net of current portion ​ 239 ​ 28 Total lease liabilities ​ $ 445 ​ $ 115 ​ The Company had no right of use lease assets and lease liabilities for financing leases as of December 31, 2022 and 2021. The table below presents certain information related to the cash flows for the Company’s operating leases for the periods ended: ​ ​ ​ ​ ​ ​ ​ ​ For the Year Ended December 31, ​ 2022 2021 Operating cash outflows from operating leases $ 265 ​ $ 276 Supplemental non-cash amounts of operating lease liabilities arising from obtaining right of use assets $ 583 ​ $ 136 ​ 63 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES 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, ​ 2022 ​ ​ 2021 ​ Weighted average remaining lease term (in years) – operating leases 2.19 ​ 1.40 Weighted average discount rate – operating leases 7.73 % ​ 6.07 % ​ 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: ​ ​ ​ ​ ​ ​ As of ​ ​ December 31, ​ ​ 2022 2023 ​ $ 234 2024 ​ 234 2025 ​ 19 Total undiscounted lease payments ​ 487 Less imputed interest ​ ( 42 ) Total net lease liabilities ​ $ 445 ​ ​ 7. NOTES PAYABLE: ​ ​ ​ ​ On January 26, 2021, the Company entered into a term loan facility agreement for the amount of $ 738 thousand. The funds were available to be drawn on from the effective date of the agreement through to January 27, 2021. The Company drew down the full loan amount on January 26, 2021. The Company’s research and development tax credit was to be utilized as collateral. The Lender was to be paid immediately following payment of research and development tax credit from the United Kingdom’s HM Revenue and Customs. The final repayment was due six months from the agreement date, if the loan and any interest was not repaid in full prior to this date. The loan carried a monthly interest rate of 1.25 %. The interest accrued daily and compounded monthly on the monthly anniversary of the draw down date of the loan. For 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 at the years ended December 31, 2022 and 2021. ​ 8. COMMITMENTS AND CONTINGENCIES: Legal proceedings In the normal course of business, the Company may become involved in legal disputes regarding various litigation matters. In the opinion of management, any potential liabilities resulting from such claims would not have a material effect on the consolidated financial statements. ​ ​ ​ 64 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ Commitments 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. ​ ​ ​ 9. STOCKHOLDERS’ EQUITY: Common Stock ​ Voting Rights ​ Each holder of common stock is entitled to one vote for each share on all matters submitted to a vote of the stockholders, including the election of directors. The Company’s amended and restated certificate of incorporation and the Company’s amended and restated bylaws do not provide for cumulative voting rights. The holders of one-third of the stock issued and outstanding and entitled to vote, present in person or represented by proxy, shall constitute a quorum for the transaction of business at all meetings of the stockholders. Dividends The Company has never paid any cash dividends to shareholders and 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 ​ 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. 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. ​ Common Stock Warrants On February 23, 2021, a total of 985,533 fully vested common stock warrants were issued to a vendor for financial advisory services provided in connection with the sale of the Company’s common stock. The common stock warrants are exercisable at a per share price of $ 2.00 until they expire on February 23, 2026. During the 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. 65 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ A summary of the Company’s warrants to purchase common stock activity is as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Weighted- ​ ​ ​ ​ ​ ​ ​ Average ​ ​ ​ ​ Weighted- ​ Remaining ​ ​ ​ ​ Average ​ Contractual ​ ​ Number of ​ Exercise ​ Term ​ ​ Shares ​ Price ​ (Years) Warrants outstanding at January 1, 2021 ​ — ​ $ — — Exercised ​ — ​ — — Forfeited or Expired ​ — ​ — — Granted ​ 985,533 ​ ​ 2.00 ​ 5.00 Warrants outstanding at January 1, 2022 985,533 ​ $ 2.00 4.15 Exercised — ​ — — Forfeited or Expired — ​ — — Granted — ​ — — Warrants outstanding at December 31, 2022 985,533 ​ $ 2.00 3.15 ​ On February 23, 2021, a total of 2,168,000 pre-funded common stock warrants were issued to investors with an exercise price of $ 0.01 per share for total proceeds to the Company of $ 4,314 thousand. During the 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 . The pre-funded common stock warrants have no expiration date and terminate upon exercise. A summary of the Company’s pre-funded warrants to purchase common stock activity is as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Weighted- ​ ​ ​ ​ Average ​ ​ Number of ​ Exercise ​ ​ Shares ​ Price Pre-funded warrants outstanding at January 1, 2021 ​ — ​ $ — Exercised ​ — ​ ​ — Forfeited or Expired ​ — ​ ​ — Granted ​ 2,168,000 ​ ​ 0.01 Pre-funded warrants outstanding at January 1, 2022 2,168,000 ​ $ 0.01 Exercised — ​ — Forfeited or Expired — ​ — Granted — ​ — Pre-funded warrants outstanding at December 31, 2022 2,168,000 ​ $ 0.01 ​ 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 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. 66 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES 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. ​ 10. 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. Subject to the adjustment provisions of the 2021 Plan, the number of shares of the Company’s common stock available for issuance under the 2021 Plan will also include an annual increase on the first day of each fiscal year beginning with 2022 fiscal year and ending on the Company’s 2031 fiscal year in an amount equal to the least of: 1) 2,275,000 shares of the Company’s common stock; 2) four percent ( 4 %) of the outstanding shares of the Company’s common stock on the last day of the immediately preceding fiscal year; or 3) such number of shares of the Company’s common stock as the administrator may determine. As 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. Of these options, 336,557 had an exercise price of $ 0.001 per share and 66,029 had an exercise price of $ 2.00 per share and all expire on the ten-year anniversary of the grant date. These options were fully vested on the grant date. ​ During the year ended December 31, 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. The Company uses the Black-Scholes option pricing model to value its share option awards. The assumptions used in calculating the fair value of share-based awards represent management’s best estimates and involves inherent uncertainties and the application of management’s judgment. As a result, if factors change and management uses different assumptions, the share-based compensation expense could be materially different for future awards. Options granted under the 2021 Plan for year ended December 31, 2022, and December 31, 2021, were valued using the Black-Scholes option-pricing model with the following assumptions: ​ ​ ​ ​ ​ ​ Year Ended ​ Year Ended ​ December 31, 2022 ​ December 31, 2021 Expected term (years) 6 years - 6.3 years ​ 5 years - 6 years Risk-free interest rate 3.1 % - 3.6 % ​ 0.3 % - 1.2 % Expected volatility 64 % ​ 54 % - 58 % Expected dividend yield 0 % ​ 0 % ​ 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. The 67 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ 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: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Weighted- ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Average ​ ​ ​ ​ ​ ​ ​ ​ ​ Weighted- ​ Remaining ​ Weighted- ​ Aggregate ​ ​ ​ ​ Average ​ Contractual ​ Average ​ Intrinsic ​ ​ Number of ​ Exercise ​ Term ​ Fair Value at ​ Value ​ ​ Shares ​ Price ​ (Years) ​ Grant Date ​ (in thousands) Options outstanding at January 1, 2021 ​ 1,810,749 ​ $ 0.06143 9.70 ​ $ 3.46867 ​ ​ ​ Exercised ​ ( 1,424,622 ) ​ 0.01447 ​ ​ ​ ​ Cancelled ​ ( 405,936 ) ​ 0.06452 ​ ​ ​ ​ Forfeited ​ ( 136,221 ) ​ ​ 0.00100 ​ ​ ​ ​ ​ ​ ​ ​ Granted ​ 2,109,912 ​ 1.68113 ​ ​ ​ ​ Options outstanding at December 31, 2021 1,953,882 ​ $ 1.72323 9.31 ​ $ 1.12355 ​ ​ ​ Exercised — ​ — ​ ​ ​ ​ Cancelled — ​ — ​ ​ ​ ​ Forfeited ​ ( 42,126 ) ​ ​ 2.00000 ​ ​ ​ ​ ​ ​ ​ ​ Granted 918,000 ​ 2.00000 ​ ​ ​ ​ Options outstanding at December 31, 2022 2,829,756 ​ $ 1.80889 8.77 ​ $ 0.98273 ​ ​ ​ Options exercisable at December 31, 2022 ​ 986,636 ​ $ 1.45189 ​ 8.26 ​ ​ ​ ​ $ 162 Vested and expected to vest after December 31, 2022 ​ 2,829,756 ​ $ 1.80889 ​ 8.77 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ 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 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 is included in the consolidated statements of operations as follows: ​ 68 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ For the Year Ended December 31, ​ 2022 2021 Research and development ​ $ 216 ​ $ 2,982 Selling, general and administrative ​ 272 ​ 3,214 Total ​ $ 488 ​ $ 6,196 ​ 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. 11. INCOME TAXES United States and foreign profit/(loss) from operations before income taxes was as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ For the Year Ended December 31, ​ 2022 2021 United States ​ $ 584 ​ $ ( 5,039 ) Foreign ​ ( 12,055 ) ​ ( 12,087 ) Loss before income taxes ​ $ ( 11,471 ) ​ $ ( 17,126 ) ​ A reconciliation of the statutory income tax rate to the Company’s effective tax rate consists of the following: ​ ​ ​ ​ ​ ​ ​ ​ Year Ended December 31, ​ 2022 2021 Taxes at domestic rate ​ 21.0 % 21.0 % State and local income taxes ​ — % — % Non-US statutory rates ​ 2.9 % ( 0.8 ) % Permanent items ​ ( 6.3 ) % ( 7.3 ) % Change in valuation allowance ​ ( 17.9 ) % ( 22.4 ) % Statutory Rate Change ​ — % 9.6 % Other ​ 0.1 % ( 0.1 ) % Effective tax rate ​ ( 0.2 ) % ( 0.0 ) % ​ 69 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ The components of income tax provision/(benefit) are as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ December 31, ​ 2022 2021 Current ​ ​ Federal ​ ​  — ​ ​  — State ​ ​ 2 ​ ​ — Foreign ​ ​ 22 ​ ​ — Total Current ​ $ 24 ​ $ — ​ ​ ​ ​ ​ ​ ​ Deferred ​ ​ ​ ​ Federal ​ ​  — ​ ​  — State ​ ​ — ​ ​ — Foreign ​ ​ — ​ ​ — Total Deferred ​ ​ — ​ ​ — Total ​ $ 24 ​ $ — ​ Deferred income taxes reflect the net tax effects of temporary differences between the carrying value of assets and liabilities for financial reporting purposes and amounts used for income tax purposes. The temporary differences that give rise to deferred tax assets and liabilities are as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ December 31, ​ 2022 2021 Deferred tax assets/(liabilities): ​ ​ ​ Net operating loss carryforwards ​ $ 9,151 ​ $ 7,506 Property plant and equipment ​ ( 150 ) ​ ( 190 ) Other ​ 68 ​ 229 ​ ​ 9,069 ​ 7,545 Valuation allowance ​ ( 9,069 ) ​ ( 7,545 ) Deferred tax assets, net of allowance ​ $ — ​ $ — ​ The Company recorded a full valuation allowance against its net deferred tax assets as of December 31, 2022, and 2021. The Company considered the positive and negative evidence bearing upon its ability to realize the deferred tax assets. In addition to the Company’s history of cumulative losses, the Company cannot be certain that future taxable income will be sufficient to realize its deferred tax assets. Accordingly, a full valuation allowance has been provided against its net deferred tax assets. When the Company changes its determination as to the amount of its deferred tax assets that can be realized, the valuation allowance is adjusted with a corresponding impact to the provision for income taxes in the period in which such determination is made. As of December 31, 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 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, 2022, open years related to the United States and United Kingdom are 2019 to 2021. 70 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES 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. ​ 12. DEFINED CONTRIBUTION PENSION: The Company operates a defined contribution pension scheme. The assets of the scheme are held separately from those of the Company in an independently administered fund. The pension cost charge represents contributions payable by the Company to the fund. Pension cost is included in the consolidated statements of operations as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ For the Years End December 31, ​ 2022 2021 Research and development ​ $ 108 ​ $ 98 Selling, general and administrative ​ 52 ​ 42 Total pension cost ​ $ 160 ​ $ 140 ​ 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. ​ 13. RELATED PARTY TRANSACTIONS: 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, 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. ​ 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. 14. 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 %) 71 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ​ 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. ​ ​ ​ ​ ​ 72 Table of Contents ITEM 9 . Changes In And Disagreements With Accountants On Accounting And Financial Disclosure ​ None. ​