28438003183515320001817760--12-312022Q10025554309265668090.100.511false0001817760us-gaap:RetainedEarningsMember2022-03-310001817760us-gaap:AdditionalPaidInCapitalMember2022-03-310001817760us-gaap:AccumulatedOtherComprehensiveIncomeMember2022-03-310001817760us-gaap:RetainedEarningsMember2021-12-310001817760us-gaap:AdditionalPaidInCapitalMember2021-12-310001817760us-gaap:AccumulatedOtherComprehensiveIncomeMember2021-12-310001817760us-gaap:RetainedEarningsMember2021-03-310001817760us-gaap:AdditionalPaidInCapitalMember2021-03-310001817760us-gaap:AccumulatedOtherComprehensiveIncomeMember2021-03-310001817760us-gaap:RetainedEarningsMember2020-12-310001817760us-gaap:AdditionalPaidInCapitalMember2020-12-310001817760us-gaap:AccumulatedOtherComprehensiveIncomeMember2020-12-310001817760us-gaap:CommonStockMember2022-03-310001817760us-gaap:CommonStockMember2021-12-310001817760us-gaap:CommonStockMember2021-03-310001817760us-gaap:CommonStockMember2020-12-3100018177602021-01-012021-12-310001817760smtk:EquityIncentivePlan2021Member2022-01-012022-03-310001817760us-gaap:EmployeeStockOptionMembersmtk:ExercisePriceRangeTwoMember2021-02-282021-02-280001817760us-gaap:EmployeeStockOptionMembersmtk:ExercisePriceRangeOneMember2021-02-282021-02-280001817760us-gaap:EmployeeStockOptionMembersmtk:EquityIncentivePlan2021Member2021-02-282021-02-280001817760smtk:EquityIncentivePlan2021Member2021-02-232021-02-230001817760us-gaap:EmployeeStockOptionMembersmtk:InvestmentAgreementForOptionsIssueMember2022-01-012022-03-310001817760us-gaap:EmployeeStockOptionMember2021-02-282021-02-280001817760smtk:OctopusSharePurchaseMember2022-01-270001817760smtk:OctopusSharePurchaseMember2022-01-272022-01-270001817760us-gaap:SoftwareDevelopmentMember2022-03-310001817760us-gaap:MachineryAndEquipmentMember2022-03-310001817760us-gaap:FurnitureAndFixturesMember2022-03-310001817760us-gaap:SoftwareDevelopmentMember2021-12-310001817760us-gaap:MachineryAndEquipmentMember2021-12-310001817760us-gaap:FurnitureAndFixturesMember2021-12-310001817760us-gaap:AccumulatedOtherComprehensiveIncomeMember2022-01-012022-03-310001817760us-gaap:AccumulatedOtherComprehensiveIncomeMember2021-01-012021-03-310001817760smtk:TermLoanFacilityAgreementMember2022-03-310001817760us-gaap:RetainedEarningsMember2022-01-012022-03-310001817760us-gaap:RetainedEarningsMember2021-01-012021-03-310001817760srt:MinimumMember2022-03-310001817760srt:MaximumMember2022-03-310001817760smtk:TermLoanFacilityAgreementMember2022-01-012022-03-310001817760smtk:TermLoanFacilityAgreementMember2021-01-012021-03-310001817760us-gaap:AccountsPayableAndAccruedLiabilitiesMember2022-03-310001817760us-gaap:AccountsPayableAndAccruedLiabilitiesMember2021-12-310001817760smtk:TermLoanFacilityAgreementMember2021-01-262021-01-260001817760smtk:TermLoanFacilityAgreementMember2021-03-310001817760smtk:PreFundedWarrantsMember2021-02-230001817760smtk:CommonStockWarrantsMember2021-02-2300018177602021-03-3100018177602020-12-310001817760us-gaap:WarrantMember2022-01-012022-03-310001817760us-gaap:EmployeeStockOptionMember2022-01-012022-03-310001817760us-gaap:WarrantMember2021-01-012021-03-310001817760us-gaap:EmployeeStockOptionMember2021-01-012021-03-310001817760us-gaap:SellingGeneralAndAdministrativeExpensesMember2022-01-012022-03-310001817760us-gaap:ResearchAndDevelopmentExpenseMember2022-01-012022-03-310001817760us-gaap:SellingGeneralAndAdministrativeExpensesMember2021-01-012021-03-310001817760us-gaap:ResearchAndDevelopmentExpenseMember2021-01-012021-03-310001817760us-gaap:AdditionalPaidInCapitalMember2021-01-012021-03-310001817760smtk:PreFundedWarrantsMember2021-02-232021-02-230001817760smtk:CommonStockWarrantsMember2021-02-232021-02-230001817760smtk:SecuritiesExchangeAgreementSmartkemLimitedMember2021-02-230001817760smtk:SecuritiesExchangeAgreementSmartkemLimitedMember2021-02-232021-02-230001817760smtk:EquityIncentivePlan2021Member2021-02-230001817760us-gaap:CommonStockMember2022-01-012022-03-310001817760us-gaap:AdditionalPaidInCapitalMember2022-01-012022-03-3100018177602021-01-012021-03-310001817760us-gaap:CommonStockMember2021-01-012021-03-310001817760smtk:TermLoanFacilityAgreementMember2021-01-260001817760smtk:PreFundedWarrantsMember2022-03-310001817760smtk:PreFundedWarrantsMember2021-12-310001817760smtk:CommonStockWarrantsMember2021-12-310001817760smtk:CommonStockWarrantsMember2022-03-310001817760smtk:CommonStockWarrantsMember2022-01-012022-03-310001817760smtk:PreFundedWarrantsMember2022-01-012022-03-310001817760us-gaap:CommonClassAMembersmtk:SecuritiesExchangeAgreementSmartkemLimitedMember2021-02-232021-02-2300018177602022-03-3100018177602021-12-3100018177602022-05-1200018177602022-01-012022-03-31xbrli:sharesiso4217:USDxbrli:pureiso4217:USDxbrli:sharessmtk:Votesmtk:patentsmtk:segment

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2022

or

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File Number: 000-56181

SmartKem, Inc.

(Exact name of registrant as specified in its charter)

Delaware

    

85-1083654

(State or other jurisdiction of

(I.R.S. Employer

incorporation or organization)

Identification Number)

Manchester Technology Centre, Hexagon Tower.

Delaunays Road, Blackley

Manchester, M9 8GQ U.K.

(Address of Principal Executive Offices)

011-44-161-721-1514

(Registrant’s telephone number)

Securities registered pursuant to Section 12(b) of the Act: None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes    No  

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes    No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes    No  

As of May 12 2022, there were 26,566,809 of the registrant’s shares of common stock outstanding.

Table of Contents

TABLE OF CONTENTS

Page

Part I

Financial Information

Item 1.

Financial Statements

3

Condensed Consolidated Balance Sheets as of March 31, 2022 and December 31, 2021

3

Condensed Consolidated Statements of Operations and Comprehensive Loss for the three months ended March 31, 2022 and 2021

4

Condensed Consolidated Statements of Stockholders’ Equity for the three months ended March 31, 2022 and 2021

5

Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2022 and 2021

6

Notes to the Unaudited Interim Condensed Consolidated Financial Statements

7

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

24

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

31

Item 4.

Controls and Procedures

31

Part II

Other Information

Item 1.

Legal Proceedings

32

Item 1A.

Risk Factors

32

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

33

Item 3.

Defaults Upon Senior Securities

33

Item 4.

Mine Safety Disclosures

33

Item 5.

Other Information

34

Item 6.

Exhibits

34

Exhibit Index

35

Signatures

37

2

Table of Contents

PART I —FINANCIAL INFORMATION

Item 1. Financial Statements

SMARTKEM, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(in thousands, except number of shares and per share data)

March 31, 

December 31, 

    

2022

    

2021

ASSETS

 

(UNAUDITED)

 

Current assets:

 

  

 

  

Cash and cash equivalents

$

10,647

$

12,226

Accounts receivable

 

30

 

Research and development tax credit receivable

 

1,324

 

1,070

Prepaid expenses and other current assets

 

1,265

 

802

Total current assets

 

13,266

 

14,098

Property, plant equipment, net of accumulated depreciation of $1,130 and $1,102

 

770

 

802

Right-of-use assets, net

 

90

 

154

Other assets

 

6

 

6

Total assets

$

14,132

$

15,060

LIABILITIES AND STOCKHOLDERS' EQUITY

 

  

 

  

Accounts payable and accrued expenses

$

1,160

$

1,423

Current lease liabilities

 

56

 

87

Total current liabilities

 

1,216

 

1,510

Non-current lease liabilities

 

19

 

28

Total liabilities

 

1,235

 

1,538

Commitments and contingencies (Note 8)

Stockholders’ Equity:

 

  

 

  

Common stock, par value $0.0001 per share, 300,000,000 shares authorized, 26,566,809 and 25,554,309 shares issued and outstanding, at March 31, 2022 and December 31, 2021, respectively*

 

3

 

3

Additional paid-in capital

 

91,935

 

89,954

Accumulated other comprehensive loss

 

(1,207)

 

(1,363)

Accumulated deficit

 

(77,834)

 

(75,072)

Total Stockholders’ equity

 

12,897

 

13,522

Total Liabilities and Stockholders’ Equity

$

14,132

$

15,060

*

Please refer to Note 1

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

3

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Operations and Comprehensive Loss (Unaudited)

(in thousands, except number of shares and per share data)

Three Months Ended March 31, 

    

2022

    

2021

Revenue

$

30

$

Cost of revenue

 

23

 

Gross profit

 

7

 

Other operating income

 

284

 

433

Operating Expenses:

 

  

 

  

Research and development

 

1,459

 

4,013

Selling, general and administrative

 

1,240

 

3,983

Transaction expenses

 

 

1,314

Total operating expenses

 

2,699

 

9,310

Loss from operations

 

(2,408)

 

(8,877)

Non-operating (Expense)/Income

 

  

 

  

(Loss) on foreign currency transactions

 

(354)

 

(470)

Interest expense

 

 

(19)

Total non-operating (expense)

 

(354)

 

(489)

Loss before income taxes

 

(2,762)

 

(9,366)

Income tax expense

 

 

Net loss

$

(2,762)

$

(9,366)

Net loss

$

(2,762)

$

(9,366)

Other comprehensive loss:

 

  

 

  

Foreign currency translation

 

156

 

16

Total comprehensive loss

$

(2,606)

$

(9,350)

Basic & diluted net loss per common share

$

(0.10)

$

(0.51)

Basic & diluted weighted average shares outstanding

28,438,003

18,351,532

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

4

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Stockholders’ Equity (Unaudited)

For the Three Months Ended March 31,

(in thousands, except share data)

Accumulated

Additional

Other

Common stock

Paid-in

Comprehensive

Accumulated

Stockholders’

    

Shares

    

Amount

    

Capital

    

Loss

    

Deficit

    

 Equity (Deficit)

Balance at January 1, 2021

 

13,627,887

1

61,276

(1,480)

(57,946)

$

1,851

Issuance of common shares due to exercise of stock-options

1,404,813

 

1

 

19

 

-

 

-

20

Stock-based compensation expense

-

 

-

 

6,020

 

-

 

-

6,020

Repurchase of common stock

(2,307,700)

 

-

 

-

 

-

 

-

-

Effect of reverse capitalization

2,500,000

 

-

 

-

 

-

 

-

-

Issuance of common shares to vendor

50,000

 

-

 

99

 

-

 

-

99

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

-

 

-

 

-

 

16

 

-

16

Net loss

 

-

 

-

 

-

 

 

(9,366)

 

(9,366)

Balance at March 31, 2021

25,437,000

3

89,597

(1,464)

(67,312)

20,824

Accumulated

Additional

Other

Common stock

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

 

-

 

-

 

98

 

-

 

-

 

98

Issuance of common shares to vendor

 

12,500

 

-

 

43

 

-

 

-

 

43

Issuance of common stock in private placement (note 13)

 

1,000,000

 

-

 

2,000

 

-

 

-

 

2,000

Issuance costs related to common stock in private placement

 

-

 

-

 

(160)

 

-

 

-

 

(160)

Foreign currency translation adjustment

 

-

 

-

 

-

 

156

 

-

 

156

Net loss

 

-

 

-

 

-

 

-

 

(2,762)

 

(2,762)

Balance at March 31, 2022

26,566,809

3

91,935

(1,207)

(77,834)

12,897

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

5

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows (Unaudited)

(in thousands)

Three Months Ended March 31, 

2022

    

2021

Cash flows from operating activities:

  

 

  

Net loss

$

(2,762)

$

(9,366)

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

 

  

 

  

Depreciation

 

54

 

48

Common shares issued to vendor for services

 

43

 

99

Amortization of right of use asset

 

63

 

47

Stock-based compensation

98

6,020

Change in operating assets and liabilities:

 

 

Accounts receivable, net

 

(30)

 

19

Research & development tax credit receivable

 

(284)

 

(248)

Prepaid expenses and other current assets

 

(471)

 

(963)

Accounts payable and accrued expenses

 

(240)

 

659

Lease liabilities

 

(40)

 

(55)

Other assets

 

 

(1)

Net cash used in operating activities

 

(3,569)

 

(3,741)

Cash flows from investing activities:

 

  

 

  

Purchases of property, plant and equipment

 

(41)

 

Net cash used by investing activities

 

(41)

 

Cash flows from financing activities:

 

  

 

  

Proceeds from term loan payable

 

 

739

Repayment of term loan payable

(739)

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

 

(160)

(2,454)

Proceeds from the exercise of stock options

 

 

20

Net cash provided by financing activities

 

1,840

 

22,204

Effect of exchange rate changes on cash

 

191

 

7

Net change in cash

 

(1,579)

 

18,470

Cash, beginning of period

 

12,226

 

764

Cash, end of period

$

10,647

$

19,234

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

 

  

 

  

Cash paid for interest

$

$

19

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

6

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Interim Condensed Consolidated Financial Statements

(Unaudited)

1.    BUSINESS AND BASIS OF PREPARATION

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.

SmartKem 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.

Basis for Presentation

These unaudited interim condensed 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 (“U.S. GAAP”) for interim reporting and are presented in thousands, except number of shares and per share data. Accordingly, certain notes or other information that are normally required by U.S. GAAP have been omitted if they substantially duplicate the disclosures contained in the Company’s annual audited consolidated financial statements. Accordingly, the unaudited interim condensed consolidated financial statements should be read in connection with the Company’s audited financial statements and related notes as of and for the year ended December 31, 2021. The accompanying interim condensed consolidated financial statements are unaudited; however, in the opinion of management, they include all normal and recurring adjustments necessary for a fair presentation of the Company’s unaudited interim condensed consolidated financial statements for the periods presented. Results of operations reported for interim periods are not necessarily indicative of results for the entire year.

Comprehensive loss of all periods presented is comprised primarily of net loss and foreign currency translation adjustments.

Going Concern

The accompanying unaudited interim condensed consolidated financial statements have been presented on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the ordinary course of business.

Since inception, we have incurred recurring losses including net losses of $2.8 million for the three months ended March 31, 2022. As of March 31, 2022 we had an accumulated deficit of $77.8 million. The Company’s cash as of March 31, 2022 was $10.6 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.

Management believes that the Company’s existing cash as of March 31, 2022 will be sufficient to fund the operations of the Company through to April 2023 and that the Company will require additional capital to continue its operations and research and development activity thereafter.

7

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Interim Condensed Consolidated Financial Statements

(Unaudited)

There can be no assurance, however, that such financing will be available when needed, if at all, or on acceptable terms and conditions. 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, the quality of product development efforts, management of working capital, and the continuation of normal payment terms and conditions for purchase of services.

In order to address its capital needs, including its planned research and development activities and other expenditures, the Company is assessing options for financing our working capital requirements through a combination of equity offerings, debt financings, collaborations, strategic alliances and marketing, distribution or licensing arrangements. Adequate financing opportunities might not be available to the Company, when and if needed, on acceptable terms or at all.

If the Company is unable to obtain additional financing in sufficient amounts or on acceptable terms, the Company will be forced to delay, reduce or eliminate some or all of its research and development programs and product portfolio expansion, which could adversely affect its operating results or business prospects. Although management continues to pursue these plans, there is no assurance that the Company will be successful in obtaining sufficient funding on terms acceptable to the Company to fund continuing operations, if at all. After considering the uncertainties, management consider it is appropriate to continue to adopt the going concern basis in preparing the consolidated financial statements. The accompanying unaudited interim condensed consolidated financial statements do not include any adjustments that might be necessary should we be unable to continue as a going concern.

Reverse Recapitalization

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 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 U.S. 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.

8

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Interim Condensed Consolidated Financial Statements

(Unaudited)

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 Limited 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”).

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 of Consolidation

The unaudited interim condensed 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 interim condensed consolidated financial statements in conformity U.S. 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 financial statements, and the reported amounts of revenues and expenses during the reporting period. The most significant estimates in the Company’s unaudited interim condensed consolidated financial statements relates to the valuation of common share, fair value of share options, 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 financial statements, actual results may materially vary from these estimates.

9

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Interim Condensed Consolidated Financial Statements

(Unaudited)

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 March 31, 2022 and December 31, 2021, the Company did not have any cash equivalents.

Accounts Receivable

Accounts receivable are stated at the amount the Company expects to collect and do not bear interest. The Company considers the following factors when determining the collectability of specific customer accounts: customer credit-worthiness, past transaction history with the customer, current economic industry trends, and changes in customer payment terms. These receivables have historically been paid timely. Due to the nature of the accounts receivable balance, the Company believes there is no significant risk of non-collection. If the financial condition of the Company’s customers were to deteriorate, adversely affecting their ability to make payments, allowances for doubtful accounts would be required. There was no allowance for doubtful accounts recorded as of March 31, 2022 and December 31, 2021.

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 condensed consolidated statements of operations. Reversal of previously recorded impairment losses are prohibited. As of March 31, 2022 and December 31, 2021, Company’s management believed that no revision to the remaining useful lives or impairment of the Company’s long-lived assets was required.

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 instruments 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 unaudited interim condensed consolidated financial statements. The Company determined that all outstanding warrants meet the criteria to be classified as equity.

Leases

Operating lease assets are included within operating lease right-of-use assets, and the corresponding operating lease obligation on the unaudited condensed consolidated balance sheets as of March 31, 2022 and December 31, 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 in determining the present value of lease payments.

10

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Interim Condensed Consolidated Financial Statements

(Unaudited)

Revenue

The Company applies the provisions of ASC 606 Revenue from Contracts with Customers. The Company recognizes revenue under the core principle to depict the transfer of control to the Company’s customers in an amount reflecting the consideration the Company expects to be entitled to. In order to achieve that core principle, the Company applies the following five step approach: (1) identify the contract with a customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contact and (5) recognize revenue when a performance obligation is satisfied.

The Company’s current contracts with customers do not contain significant estimates or judgments. All of the Company’s revenue contains a single performance obligation that is recognized upon fulfilment of the sales order.

The Company derives its revenues primarily from sales of demonstrator units to customers evaluating organic semiconductor technology. The transaction price is stated in each customer agreement and is allocated to a single performance obligation. Revenue is recognized upon shipment of each demonstrator, at a point in time. The Company 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 expenses as incurred when the amortization period is less than a year.

Other Operating Income

The Company’s other operating income is related to government grant incentives received for qualifying research and development projects, and research and development tax credits related to the United Kingdom’s Research and Development Expenditure Credit scheme, which is a government tax incentive designed to reward innovative companies for investing in research and development. Such incentives are recorded as other income when it is probable the amounts are collectible and can be reasonably estimated.

For the three months ended March 31, 2022 and 2021, the Company recorded grant income and research & development tax credits of $284 thousand and $433 thousand, respectively. As of March 31, 2022, and December 31, 2021, the Company had receivables related to research & development tax credits for payments not yet received of $1,324 thousand and $1,070 thousand, respectively.

Share-based compensation

All share-based payments, including grants of stock options, are measured based on the fair value of the share-based awards at the grant date and recognized over their respective vesting periods. Outstanding options generally expire 10 years after the grant date. The Company has issued options that vest based on service requirements and issued options that vest based on performance requirements. Options become exercisable when service requirements are met. In the case of performance based options, options become exercisable when there is a liquidity event, such as a change in control or sale or admission (listing as a public company or initial public offering (“IPO”)), and the employee, or consultant, must be providing services to the Company at the time of the event. Due to the Exchange, all options outstanding immediately prior to the event with a performance obligation requirement became vested and exercisable.

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.

11

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Interim Condensed Consolidated Financial Statements

(Unaudited)

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 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).

From the date of the Exchange forward, the Company’s functional currency is the U.S. dollar (“USD”). The functional currency of the Company’s foreign operation is the respective local currency. Assets and liabilities of foreign operation denominated in local currencies are translated at the spot rate in effect at the applicable reporting date. The condensed consolidated statements of operations and comprehensive loss are translated at the weighted average rate of exchange during the applicable period. The resulting unrealized gain/loss is recognized as foreign currency translation as a component of other comprehensive income.

Income Taxes

Income taxes are recorded in accordance with ASC 740, Income Taxes (“ASC 740”), which provides for deferred taxes using an asset and liability approach. The Company recognizes deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the 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.

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 March 31, 2022 and December 31, 2021, there were no accruals for uncertain tax positions.

Contingent Liabilities

A provision for contingent liabilities is recorded when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. With respect to legal matters, provisions are reviewed and adjusted to reflect the impact of negotiations, estimated settlements, legal rulings, advice of legal counsel and other information and events pertaining to a particular matter. The Company is a party to certain litigation and disputes arising in the normal course of business. As of March 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

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 condensed consolidated balance sheet until

12

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Interim Condensed Consolidated Financial Statements

(Unaudited)

completion of the issuance. Upon completion of the issuance, deferred offering costs are reclassified from other assets to equity and recorded against the net proceeds received in the issuance. For the three months ended March 31, 2022 and 2021 respectively, $160 thousand and $2,454 thousand of offering costs were recorded in additional paid-in capital. No offering costs were deferred as of both March 31, 2022 and December 31, 2021.

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 unaudited interim condensed consolidated financial statements is reflected and calculated as if the Company had existed since January 1, 2020. Accordingly, loss per share for all periods was calculated based on the number of shares retroactively adjusted for the exchange ratio determined in the reverse recapitalization (see also note 1).

The Company has 2,168,000 pre-funded common stock warrants outstanding as of March 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.

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

March 31, 

    

2022

    

2021

Options

1,953,882

1,546,562

Warrants

 

985,533

 

3,153,533

Total

2,939,415

4,700,095

Recent Accounting Pronouncements Adopted

In May 2021, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) No. 2021-04, Issuer's Accounting for Certain Modifications or Exchanges of Freestanding Equity Classified Written Call Options" ("ASU 2021-04"), which introduces a new way for companies to account for warrants either as stock compensation or derivatives. Under the new guidance, if the modification does not change the instrument's classification as equity, the company accounts for the modification as an exchange of the original instrument for a new instrument. In

13

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Interim Condensed Consolidated Financial Statements

(Unaudited)

general, if the fair value of the "new" instrument is greater than the fair value of the "original" instrument, the excess is recognized based on the substance of the transaction, as if the issuer has paid cash. The effective date of the standard is for interim and annual reporting periods beginning after December 15, 2021 for all entities, and early adoption is permitted. The Company adopted ASU 2021-04 on January 1, 2022. As a result of Management’s evaluation, the adoption of ASU 2021-04 did not have a material impact on the consolidated financial statements.

In November 2021, the FASB issued ASU 2021-10, Government Assistance (Topic 832) ("ASU 2021-10"), which provides guidance on disclosing government assistance. Under the new guidance, the Company is required to including the disclosure of (1) the types of assistance, (2) an entity's accounting for the assistance, and (3) the effect of the assistance on the entity's financial statements. The effective date of the standard is for annual periods beginning after December 15, 2021. The Company adopted ASU 2021-10 on January 1, 2022. As a result of Management’s evaluation, the adoption of ASU 2021-10 did not have a material on the consolidated financial statements.

Recent Accounting Pronouncements Not Adopted

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments: Credit Losses (Topic 326), which requires measurement and recognition of expected losses for financial assets held. The new standard changes the impairment model for most financial instruments, including trade receivables, from an incurred loss method to a new-forward looking approach, based on expected losses. The estimate of expected credit losses will require organizations to incorporate considerations of historical information, current conditions and reasonable and supportable forecasts. The standards update is effective prospectively for annual and interim periods in fiscal years beginning after December 15, 2019, with early adoption permitted, for U.S. Securities Exchange filer, excluding entities eligible to be smaller reporting companies. The standards update is effective prospectively for annual and interim periods beginning after December 15, 2022. Management is currently evaluating the impact of these changes on the Financial Statements.

Reclassifications

Certain amounts in prior periods' interim condensed consolidated financial statements have been reclassified to conform to the current period’s presentation.

3.    PREPAID EXPENSES AND OTHER CURRENT ASSETS:

Prepaid expenses and other current assets consist of the following:

March 31, 

December 31, 

    

2022

    

2021

Prepaid service charges and property taxes

$

74

$

58

Prepaid utilities

 

6

 

51

Prepaid insurance

 

805

 

412

Prepaid administrative expenses

 

149

 

63

Prepaid technical fees

72

141

Prepaid consulting fees

51

27

VAT receivable

 

107

 

50

Other Receivable and other prepaid expenses

1

Total prepaid expenses and other current assets

$

1,265

$

802

As of March 31, 2022 and December 31, 2021, there was $204 thousand and $217, thousand respectively, of non-current prepaid insurance related to directors’ and officers’ liability insurance that was included in the amounts above.

14

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Interim Condensed Consolidated Financial Statements

(Unaudited)

4.    PROPERTY, PLANT AND EQUIPMENT:

Property, plant and equipment consist of the following:

March 31, 

December 31, 

    

2022

    

2021

Plant and equipment

$

1,635

$

1,633

Furniture and fixtures

 

239

 

245

Computer hardware and software

 

26

 

26

 

1,900

 

1,904

Less: Accumulated depreciation

 

(1,130)

 

(1,102)

Property, plant and equipment, net

$

770

$

802

Depreciation expense was $54 thousand and $48 thousand for three months ended March 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:

March 31, 

December 31, 

    

2022

    

2021

Accounts payable

$

381

$

510

Accrued expenses – lab refurbishments

 

128

 

131

Accrued expenses – technical fees

 

76

 

66

Accrued expenses – variable rent & utilities

 

6

 

20

Accrued expenses – audit & accounting fees

 

181

 

191

Accrued expenses – other

 

60

 

112

Credit card liabilities

 

13

 

10

Payroll and social security liabilities

 

315

 

383

Total accounts payable and accrued expenses

$

1,160

$

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 three months ended March 31, 2022 and 2021. The Company is not the lessor in any lease agreement, and no related party transactions for lease arrangements have occurred.

15

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Interim Condensed Consolidated Financial Statements

(Unaudited)

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

For the Three Months Ended March 31, 

    

2022

    

2021

Operating lease cost

$

63

$

47

Short-term lease cost

 

2

 

13

Variable lease cost

 

54

 

23

Total lease cost

$

119

$

83

The total lease cost is included in the unaudited condensed consolidated statements of operations as follows:

For the Three Months Ended March 31, 

    

2022

    

2021

Research and development

$

113

$

70

Selling, general and administrative

 

6

 

13

Total lease cost

$

119

$

83

Right of use lease assets and lease liabilities for our operating leases were recorded in the unaudited condensed consolidated balance sheet as follows:

    

March 31, 

December 31, 

    

2022

    

2021

Assets

  

 

  

Operating lease right of use assets

$

90

$

154

Total lease assets

$

90

$

154

Liabilities

 

  

 

  

Current liabilities:

 

  

 

  

Operating lease liability – current portion

$

56

$

87

Noncurrent liabilities:

 

  

 

Operating lease liability, net of current portion

 

19

 

28

Total lease liabilities

$

75

$

115

The Company had no right of use lease assets and lease liabilities for financing leases as of March 31, 2022 and December 31, 2021.

16

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Interim Condensed Consolidated Financial Statements

(Unaudited)

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

For the Three Months Ended March 31, 

2022

    

2021

Operating cash outflows from operating leases

$

40

$

55

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 Three Months Ended March 31, 

2022

2021

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

1.42

 

1.10

 

Weighted average discount rate – operating leases

6.03

%  

6.30

%  

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

    

As of 

March 31, 

2022

2022

$

50

2023

 

22

2024

 

7

2025

 

2026

 

Thereafter

 

Total undiscounted lease payments

 

79

Less imputed interest

 

(4)

Total net lease liabilities

$

75

7.     NOTES PAYABLE:

On January 26, 2021, the Company entered into a term loan facility agreement for the amount of $739 thousand. The funds were available to be drawn on from the effective date of the agreement through 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. The Company repaid the note payable in full on March 2, 2021.

For three months ended March 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 nine months ended March 31, 2021, was $19 thousand.

17

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Interim Condensed Consolidated Financial Statements

(Unaudited)

There were no notes payable outstanding during the three months ended March 31, 2022 and no associated interest expense during the period.

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 financial statements.

Capital expenditure commitments and unconditional purchase obligations contracted for but not yet incurred as of March 31, 2022, totaled $1,350 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 do not anticipate paying any cash dividends to shareholders in the foreseeable future. Any future determination to pay cash dividends will be at the discretion of our board of directors and will be dependent upon financial condition, results of operations, capital requirements and such other factors as the board of directors deems relevant.

Market Information

Quotations on our common stock on the OTC Market Group’s OTCQB® Market quotation system (“OTCQB”) commenced under the ticker symbol “SMTK” in February 2022. There was no trading of our common stock on the OTCQB or any other over-the-counter market prior to February 2022.

Preferred Stock

The Company currently has no shares of preferred stock outstanding, and the Company has no present plan to issue any shares of preferred stock. The board of directors has the authority, without further action by the stockholders, to issue up to 10,000,000 shares of preferred stock in one or more series and to fix the rights, preferences, privileges and

18

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Interim Condensed Consolidated Financial Statements

(Unaudited)

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 three months ended March 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 three months ended March 31, 2021. There were no warrants issued during the three months ended March 31, 2022.

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, 2022

 

985,533

$

2.00

 

4.15

Exercised

 

 

 

Forfeited or Expired

 

 

 

Granted

 

 

-

 

Warrants outstanding at March 31, 2022

 

985,533

$

2.00

 

3.90

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 three months ended March 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, 2022

 

2,168,000

$

0.01

Exercised

 

 

Forfeited or Expired

 

 

Granted

 

 

Pre-funded warrants outstanding at March 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 estimates its expected stock

19

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Interim Condensed Consolidated Financial Statements

(Unaudited)

volatility based on historical volatility of publicly traded peer companies. The Company did not issue any warrants in the three months ended March 31, 2022.

10.    SHARE-BASED COMPENSATION:

Prior to the Exchange discussed in Note 1, SmartKem Limited had stock option plans.

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. The options generally expired 10 years after the grant date and were subject to vesting conditions and became fully vested and exercisable when there was a liquidity event, such as a change in control, and the employee, or consultant, was providing services to the Company at the time of the event. As of December 31, 2020, there were 1,810,749 options outstanding. These options were either exercised or cancelled as a result of the reverse merger and recapitalization.

On February 23, 2021, the Company approved the 2021 Equity Incentive Plan (“2021 Plan”), in which a maximum aggregate number of shares of common stock that may be issued under the 2021 Plan is 2,275,000 shares. Subject to the adjustment provisions of the 2021 Plan, the number of shares of the Company’s common stock available for issuance under the 2021 Plan will also include an annual increase on the first day of each fiscal year beginning with 2022 fiscal year and ending on the Company’s 2031 fiscal year in an amount equal to the least of: 1) 2,275,000 shares of the Company’s common stock; 2) four percent (4%) of the outstanding shares of the Company’s common stock on the last day of the immediately preceding fiscal year; or 3) such number of shares of the Company’s common stock as the administrator may determine.

As a result of the reverse merger and recapitalization, an aggregate of 402,586 options were issued during February 2021 under the 2021 Plan in consideration for the cancellation of the SmartKem Limited options that were outstanding. Of these options, 336,557 had an exercise price of $0.001 per share and 66,029 had an exercise price of $2.00 per share and all expire on the ten year anniversary of the grant date. These options were fully vested on the grant date.

No options were awarded during the three months ended March 31, 2022.

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.

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.

20

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Interim Condensed Consolidated Financial Statements

(Unaudited)

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. The following table reflects share activity under the share option plans for three months ended March 31, 2022:

    

    

    

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, 2022

 

1,953,882

$

1.72323

 

9.31

$

1.12355

$

Exercised

 

 

 

  

 

  

Cancelled

 

 

 

  

 

  

Forfeited

Granted

 

 

 

  

 

  

Options outstanding at March 31, 2022

 

1,953,882

$

1.72323

 

9.06

$

1.12355

$

Options exercisable at March 31, 2022

622,549

$

1.13134

8.95

$

1,475

Vested and expected to vest after March 31, 2022

1,953,882

$

1.72323

9.06

$

3,472

As of March 31, 2022, there were 622,549 exercisable options outstanding.

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

For the Three Months Ended March 31, 

2022

    

2021

Research and development

$

40

$

2,908

Selling, general and administrative

 

58

 

3,112

Total

$

98

$

6,020

Total compensation cost related to non-vested stock option awards not yet recognized as of March 31, 2022 was $1,234 thousand and will be recognized on a straight-line basis through the end of the vesting periods in September 2025. The amount of future stock option compensation expense could be affected by any future option grants or by any forfeitures.

21

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Interim Condensed Consolidated Financial Statements

(Unaudited)

11.    SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:

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

    

For the Three Months Ended March 31, 

    

2022

    

2021

Salaries and benefits

$

500

$

3,734

Rent and property tax expense

 

28

 

13

Insurance

166

81

Utilities

 

1

 

1

Sales and marketing

 

187

 

22

Legal and professional fees

 

289

 

122

Other selling, general, and administrative expenses

 

69

 

10

Total

$

1,240

$

3,983

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 unaudited interim condensed consolidated statements of operations as follows:

For the Three Months Ended March 31, 

    

2022

    

2021

Research and development

$

27

$

23

Selling, general and administrative

 

14

 

8

Total pension cost

$

41

$

31

As of March 31, 2022 and December 31, 2021 there were no amounts owed to the pension scheme.

13.    RELATED PARTY TRANSACTIONS:

In addition to transactions and balances related share-based compensation to officers and directors, the Company incurred expenses of $18 thousand and $7 thousand, for the three months ended March 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 unaudited interim condensed consolidated statements of operations. As of March 31, 2022 and December 31, 2021, there was $9 thousand and $18 thousand, respectively, payable to members of the Board of Directors that are recorded in accounts payable and accrued expenses on the unaudited interim condensed consolidated balance sheets.

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.

22

Table of Contents

SMARTKEM, INC. AND SUBSIDIARIES

Notes to Interim Condensed Consolidated Financial Statements

(Unaudited)

14.    SUBSEQUENT EVENTS:

In April 2022, the Company renewed its lease for research & development, engineering, testing and corporate offices in Manchester. The renewed lease term expires in 2025 with an option for the Company to end the lease in 2024.

23

Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read together with our unaudited interim condensed consolidated financial statements and the related notes and other financial information included in this Report. Some of the information contained in this discussion and analysis or set forth elsewhere in this Report, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties as described under the heading “Cautionary Note on Forward-Looking Statements” below. You should review the disclosure under the heading “Risk Factors” in this Report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statement.

CAUTIONARY NOTE ON FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q, including the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains express or implied forward-looking statements that are based on our management’s belief and assumptions and on information currently available to our management. Although we believe that the expectations reflected in forward-looking statements are reasonable, such statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by forward-looking statements. All statements other than statements of historical fact contained in this Report are forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “could,” “will,” “would,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “intend,” “predict,” “seek,” “contemplate,” “project,” “continue,” “potential,” “ongoing” or the negative of these terms or other comparable terminology.

These forward-looking statements include, but are not limited to, statements about:

the implementation of our business model and strategic plans for our business, technologies and products;
the rate and degree of market acceptance of any of our products or organic semiconductor technology in
general, including changes due to the impact of (i) new semiconductor technologies, (ii) the performance of organic semiconductor technology, whether perceived or actual, relative to competing semiconductor materials, and (iii) the performance of our products, whether perceived or actual, compared to competing silicon-based and other products;
the timing and success of our, and our customers’, product releases;
our ability to develop new products and technologies;
our estimates of our expenses, ongoing losses, future revenue and capital requirements, including our

our needs for additional financing;

our ability to obtain additional funds for our operations and our intended use of any such funds;
our ability to become listed and remain eligible on an over-the-counter quotation system;
our receipt and timing of any royalties, milestone payments or payments for products, under any current or future collaboration, license or other agreements or arrangements;
our ability to obtain and maintain intellectual property protection for our technologies and products and our ability to operate our business without infringing the intellectual property rights of others;
the strength and marketability of our intellectual property portfolio;
our dependence on current and future collaborators for developing, manufacturing or otherwise bringing our products to market;
the ability of our third-party supply and manufacturing partners to meet our current and future business needs;
our exposure to risks related to international operations;
our dependence on third-party fabrication facilities;
the impact of the COVID-19 pandemic and any future communicable disease outbreak on our business and operations;
our relationships with our executive officers, directors and significant stockholders;

24

Table of Contents

our expectations regarding our classification as a “smaller reporting company,” as defined under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and an “emerging growth company” under the JOBS Act (as defined below) in future periods;
our future financial performance;
the competitive landscape of our industry;
the impact of government regulation and developments relating to us, our competitors or our industry; and
other risks and uncertainties, including those listed under the caption “Risk Factors.”

These statements relate to future events or our future operational or financial performance, and involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements. Factors that may cause actual results to differ materially from current expectations include, among other things, those listed under “Risk Factors” and elsewhere in this Form 10-Q.

Any forward-looking statement in this Form 10-Q reflects our current view with respect to future events and is subject to these and other risks, uncertainties and assumptions relating to our business, results of operations, industry and future growth. Given these uncertainties, you should not place undue reliance on these forward looking statements. No forward-looking statement is a guarantee of future performance. You should read this Form 10-Q and the documents that we reference in this Form 10-Q and have filed with the SEC as exhibits hereto completely and with the understanding that our actual future results may be materially different from any future results expressed or implied by these forward-looking statements. Except as required by law, we assume no obligation to update or revise these forward looking statements for any reason, even if new information becomes available in the future.

Overview

We are seeking to reshape the world of electronics with a revolutionary semiconductor platform that enables a new generation of displays, sensors and logic. SmartKem’s patented TRUFLEX® inks are solution deposited at a low temperature, on low-cost substrates to make organic thin-film transistor (OTFT) circuits. Our semiconductor platform can be used in a number of applications including mini-LED displays, AMOLED displays, fingerprint sensors and logic circuits. We develop our materials at our research and development facility in Manchester, UK, and at our semiconductor manufacturing process at the Centre of Process Innovation (CPI) in Sedgefield, UK. We have an extensive IP portfolio including approximately 120 issued patents.

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

Our loss before income taxes was $2.8 million and $9.4 million for the three months ended March 31, 2022 and 2021, respectively. As of March 31, 2022, our accumulated deficit was $77.8 million. Substantially all our operating losses have resulted from expenses incurred in connection with research and development activities and from general and administrative costs associated with our operations.

Recent Developments

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.

25

Table of Contents

Nanosys Inc., Joint Development Agreement

In February 2022, we entered into a joint development agreement with Nanosys Inc., a leader in developing and delivering quantum dot and micro-LED technology. Under this agreement the two parties will work together on a new generation of low-cost solution printed micro-LED and quantum dot materials for advanced displays.

Key Factors Affecting Our Performance

There are a number of industry factors that affect our business which include, among others:

Overall Demand for Products and Applications using Organic thin film transistors

Our potential for growth depends significantly on the adoption of organic thin film transistor (OTFT) materials in the display and sensor markets and our ability to capture a significant share of any market that does develop. We expect that demand for our technology will also fluctuate based on various market cycles, continuously evolving industry supply chains, trade and tariff terms, as well as evolving competitive dynamics in each of the respective markets. These uncertainties make demand difficult to forecast for us and our customers.

Intense and Constantly Evolving Competitive Environment

Competition in the industries we serve is intense. Many companies have made significant investments in product development and production equipment. To remain competitive, market participants must continuously increase product performance, reduce costs and develop improved ways to serve their customers. To address these competitive pressures, we have invested in research and development activities to support new product development, improve ease of use, lower product costs and deliver higher levels of performance to differentiate our products in the market.

Governmental Trade and Regulatory Conditions

Our potential for growth depends on a balanced and stable trade, political, economic and regulatory environment among the countries where we do business. Changes in trade policy such as the imposition of tariffs or export bans to specific customers or countries could reduce or limit demand for our products in certain markets.

Technological Innovation and Advancement

Innovations and advancements in organic materials continue to expand the potential commercial application for our products. However, new technologies or standards could emerge, or improvements could be made in existing technologies that could reduce or limit the demand for our products in certain markets.

Intellectual Property Issues

We rely on patented and non-patented proprietary information relating to product development, manufacturing capabilities and other core competencies of our business. Protection of intellectual property is critical. Therefore, steps such as additional patent applications, confidentiality and non-disclosure agreements, as well as other security measures are important. While we believe we have a strong patent portfolio and there is no actual or, to our knowledge, threatened litigation against us for patent-related matters, litigation or threatened litigation is a common method to effectively enforce or protect intellectual property rights. Such action may be initiated by or against us and would require significant management time and expenses.

Components of Results of Operations

There have been no material changes to the key components of our Condensed Consolidated Statements of Operations as described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2021 Form 10-K.

26

Table of Contents

Results of Operations

The following tables set forth our results of operations for the periods presented. The information in the tables below should be read in conjunction with our unaudited interim condensed consolidated financial statements and related notes included in Part I, Item 1 of this Form 10-Q. The period-to-period comparisons of financial results in the tables below are not necessarily indicative of future results.

Comparison of Loss from Operations for the three month-periods ended March 31, 2022 and 2021

Our results of operations for the three month-periods ended March 31, 2022 and 2021 are as follows:

Three Months Ended March 31, 

Increase (Decrease)

 

US$000

    

2022

    

2021

    

Amount

    

Percentage

 

Revenue

 

$

30

$

 

$

30

 

100

%

Cost of revenue

 

23

 

 

23

 

100

%

Gross Profit

 

7

 

 

7

 

100

%

Other operating income

 

284

 

433

 

(149)

 

(34)

%

Operating expenses

 

 

 

  

 

  

Research and development

 

1,459

 

4,013

 

(2,554)

 

(64)

%

Selling, general and administrative

 

1,240

 

3,983

 

(2,743)

 

(69)

%

Transaction expenses

 

 

1,314

 

(1,314)

 

(100)

%

Total operating expenses

 

2,699

 

9,310