Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Our Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is provided in addition to the accompanying consolidated financial statements and notes to assist readers in understanding our results of operations, financial condition, and cash flows. The following discussion and analysis of our financial condition and results of operations should be read together with our 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” above. You should review the disclosure under the heading “Item1A. 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.
40
Table of Contents
Overview
We are seeking to reshape the world of electronics with our disruptive organic thin-film transistors (“OTFTs”) that we believe have the potential to drive the next generation of displays. Our patented TRUFLEX® semiconductor and dielectric inks, or electronic polymers, are used to make a new type of transistor that we believe have the capability to potentially revolutionize the display industry. Our inks enable low temperature printing processes that are compatible with existing manufacturing infrastructure to deliver low-cost displays that outperform existing technologies. Our electronic polymer platform can be used in a range of display technologies including microLED, miniLED and AMOLED displays for next generation televisions, laptops, augmented reality (“AR”) and virtual reality (“VR”) headsets, smartwatches and smartphones.
Our loss before income taxes was $8.5 million and $11.5 million for the year ended December 31, 2023, and 2022, respectively. As of December 31, 2023, our accumulated deficit was $95.1 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.
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 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,
41
Table of Contents
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
Revenue
Revenue. Our revenue consists of revenue from the sale of TRUFLEX® inks and demonstration products.
Cost of Revenues. Cost of revenues consists of (1) direct product costs incurred for the raw materials and manufacturing services for our products, (2) fixed product costs primarily relating to production, manufacturing and personnel and (3) depreciation consisting primarily of expenses related to our fixed assets. We expect our cost of goods sold attributable to direct product costs to increase proportionately with increases in revenue, and our cost of goods sold attributable to fixed product costs to remain substantially flat or moderately increase in connection with increases in revenue.
Other Operating Income. Our Other Operating Income includes government grants received for qualifying research and development projects, and research and development tax credits related to the United Kingdom’s Research and Development tax relief for small and medium-sized enterprises, which is a government tax incentive designed to reward innovative companies for investing in research and development. The income associated with these items is recognized in the period which the research and development expenses occurred.
Operating Expenses
Research and Development. Research and development expenses consist primarily of compensation and related costs for personnel, including share-based compensation and employee benefits as well as costs associated with design, fabrication and testing of OTFT devices. In addition, research and development expenses include depreciation expenses related to our fixed assets. We expense research and development expenses as incurred. As we continue to invest in developing our technology for new products, we expect research and development expenses to remain flat or moderately increase in absolute dollars but to decline as a percentage of revenue. We do not believe that it is possible at this time to accurately project total program-specific expenses through commercialization. There are numerous factors associated with the successful commercialization of our technology, many of which cannot be determined with accuracy at this time based on our stage of development. Additionally, future commercial and other factors beyond our control will impact our development programs and plans.
Selling, General and Administrative. Selling, general and administrative expenses consist primarily of allocated compensation and related costs for personnel, including share-based compensation, employee benefits and travel. In addition, general and administrative expenses include third-party consulting, legal, audit, accounting services, allocations of overhead costs, such as rent, facilities and information technology. We expect general and administrative expenses to increase in absolute dollars in future periods due to additional legal, accounting, insurance, investor relations and other costs associated with being a public company, as well as other costs associated with growing our business.
Non-Operating Income (Expense)
Non-operating income/expense aggregates the following amounts:
Foreign Currency Translation. Foreign currency translation reflects adjustments made due to currency fluctuations.
Transaction Costs. Costs for equity contracts that are classified as a liability.
Fair Value of Warrant Liability. The fair value of equity contracts that are classified as a liability.
42
Table of Contents
Interest Income. Interest income is interest on our cash deposits.
Income Tax Expense. Income tax expense consists primarily of income taxes in jurisdictions in which we conduct business.
Results of Operations
Twelve months ended December 31, 2023 compared with the twelve months ended December 31, 2022
Revenue and Cost of Revenue
Our revenue and cost of revenue reflects sales of TRUFLEX® inks and demonstration products and the direct costs associated with those sales.
Revenues were $27.0 thousand for the year ended December 31, 2023, compared to $40.0 thousand for the same period of 2022. Cost of revenue was $23.0 thousand for the twelve months ended December 31, 2023, compared to $33.0 thousand for the same period of 2022. The decrease is mainly the results of less unit sales in 2023 compared to 2022, reflecting the largely one-off nature of these sales, consistent with our current stage of commercialization.
Other Operating Income
Other operating income was $0.8 million and $1.2 million for the years ended December 31, 2023 and 2022, respectively. The primary sources of the other operating income in these periods were a research grant and research and development tax credits. The decrease is mostly attributable to a reduction in the allowable research and development expenses and a lowering of the tax credit rate to be applied to the allowable expenses of which both went into effect in 2023.
Operating Expenses
Operating expenses decreased by $0.1 million to $10.8 million for the year ended December 31, 2023, compared to $10.9 million for the comparable period of 2022.
Research and development expense, which represents 51.3% and 53.4% of our total operating expenses for the twelve months ended December 31, 2023 and 2022, respectively, decreased by $0.2 million to $5.6 million for the year ended December 31, 2023, compared to $5.8 million for the same period of 2022. The decrease is mainly due to lower personnel costs related to reductions in force effected in December 2022 and September 2023 and lower technical research and development costs, including consulting, testing and lab supplies.
Selling, general and administrative expense, which represents 47.9% and 46.6% of our total operating expenses for the twelve months ended December 31, 2023 and 2022, respectively, increased by $0.1 million to $5.2 million for year ended December 31, 2023 as compared to $5.1 million for the same period in 2022. There was an increase in personnel costs due to severance costs and the accrual of bonus payments in 2023. This was offset by a reduction in investor relations cost and other professional service fees.
Non-Operating Income/(Expenses) and Net Loss
The increase of $3.0 million in gain on foreign currency transactions was due to fluctuations in U.S. dollar/U.K. pound value arising from transactions denominated in foreign currencies and the translation of foreign currency denominated balances on intra-group loans.
Issuance costs of $0.2 million allocated to the warrant liability were expensed in full during the year ended December 31, 2023. The majority of costs were legal, placement and consulting fees specifically related to the private placement transaction. There were no similar gains or losses recorded during the prior year.
43
Table of Contents
A gain of $0.5 million related to the valuation of the warrant liability was recorded during the year ended December 31, 2023. There were no similar gains or losses recorded during the prior year.
The loss before income taxes was $8.5 million for the year ended December 31, 2023, a decrease of $3.0 million, compared to a loss before income taxes of $11.5 million for the year ended December 31, 2022. The decrease in the 2023 period was attributable increases in gains on foreign currency transactions and lower operating expenses as described in the preceding paragraphs.
Liquidity and Capital Resources
As of December 31, 2023, our cash and cash equivalents were $8.8 million compared with $4.2 million as of December 31, 2022. We believe this will be sufficient to fund our operating expenses and capital expenditure requirements through the end of April 2025. 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.
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.
Cash Flow from Operating Activities
Net cash used in operating activities was $8.0 million for the year ended December 31, 2023, compared to $9.0 million for the year ended December 31, 2022, a decrease of $1.0 million. The decrease resulted primarily from a decrease in our net loss of $3.0 million, partially offset by an increase of non-cash activities of $3.3 million and a net increase in operating assets and liabilities of $1.3 million.
Cash Flow from Investing Activities
Net cash used in investing activities was $18.0 thousand for the year ended December 31, 2023, compared to $79.0 thousand for the year ended December 31, 2022, a decrease of $61.0 thousand. The decrease resulted from a reduced level of investment in laboratory and capital equipment purchases in 2023.
Cash Flow from Financing Activities
Net cash flows provided by financing activities was $12.7 million for the year ended December 31, 2023, compared to $1.8 million for the year ended December 31, 2022, an increase of $10.9 million. In June 2023, we completed a private placement of our preferred stock and warrants resulting in net proceeds of $12.4 million with an additional $1.8 million related to the issuance of warrants. We incurred $1.5 million in issuance costs in connection with this private placement.
Contractual Payment Obligations
Our principal commitments primarily consist of obligations under leases for office space and purchase commitments in the normal course of business for research & development facilities and services, communications infrastructure, and administrative services. We expect to fund these commitments from our cash balances and working capital.
44
Table of Contents
Recently Issued Accounting Pronouncements
For recently issued accounting announcements, see “Recently Issued Accounting Pronouncements” in Note 2, Significant Accounting Policies and Recent Accounting Pronouncements, in the Notes to our Consolidated Financial Statements included in this Annual Report on Form 10-K.
Critical Accounting Estimates
We prepare our consolidated financial statements in accordance with U.S. generally accepted accounting principles, which require our management to make estimates that affect the reported amounts of assets, liabilities and disclosures of contingent assets and liabilities at the balance sheet dates, as well as the reported amounts of revenues and expenses during the reporting periods. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations would be affected. We base our estimates on our own historical experience and other assumptions that we believe are reasonable after taking account of our circumstances and expectations for the future based on available information. We evaluate these estimates on an ongoing basis.
We consider an accounting estimate to be critical if: (i) the accounting estimate requires us to make assumptions about matters that were highly uncertain at the time the accounting estimate was made, and (ii) changes in the estimate that are reasonably likely to occur from period to period or use of different estimates that we reasonably could have used in the current period, would have a material impact on our financial condition or results of operations.
Management has discussed the development and selection of these critical accounting estimates with the Audit Committee of our Board of Directors. In addition, there are other items within our financial statements that require estimation but are not deemed critical as defined above. Changes in estimates used in these and other items could have a material impact on our financial statements.
Share-Based Compensation
The Company determines the fair value of certain share-based awards using the Black-Scholes option-pricing model which uses both historical and current market data to estimate the fair value. This method incorporates various assumptions such as the risk-free interest rate, expected volatility, expected dividend yield, and expected life of the options. Prior to February 2022, the Company’s common stock was not traded on an over the counter or national securities exchange and consequently the Company developed estimates for the inputs to the option-pricing model.
Warrant Liability
The valuation of the warrant liability was determined using an option pricing model. This model uses inputs such as the underlying price of the shares issued at the measurement date, expected volatility, risk free interest rate and expected life of the instrument. Since our common stock was not publicly traded until February 2022 there has been insufficient volatility data available. Accordingly, we have used an expected volatility based on historical common stock volatility of our peers. In addition, we used the probability of uplisting as an input in the model to determine the fair value of the warrant liability.
JOBS Act Accounting Election
We are an emerging growth company, as defined in the JOBS Act. The JOBS Act provides that an emerging growth company can take advantage of an extended transition period for complying with new or revised accounting standards. This provision allows an emerging growth company to either early adopt or delay the adoption of some accounting standards until those standards would otherwise apply to private companies. We have elected to use the extended transition period under the JOBS Act until the earlier of the date we (i) are no longer an emerging growth company or (ii) affirmatively and irrevocably opt out of the extended transition period provided in the JOBS Act. As a result, our consolidated financial statements may not be comparable to companies that comply with new or revised accounting pronouncements as of public company effective dates.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
We are a smaller reporting company as defined in Rule 12b-2 of the Exchange Act; therefore, pursuant to Item 301(c) of Regulation S-K, we are not required to provide the information required by this Item.
45
Table of Contents
Item 8. Financial Statements and Supplementary Data
SmartKem, Inc.
Index to Consolidated Financial Statements
Page
Consolidated Balance Sheets as of December 31, 2023, and 2022 49
Notes to the Consolidated Financial Statements 53
46
Table of Contents
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors of
SmartKem, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheet of SmartKem, Inc. and subsidiaries (the “Company”) as of December 31, 2023,the related consolidated statements of operations and comprehensive loss, stockholders’ equity, and cash flows for the year ended December 31, 2023, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2023, and the results of its operations and its cash flows for the year ended December 31, 2023, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audit. 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 audit 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 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 audit, 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 audit included performing procedures to assess the risks of material misstatement of the 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 financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audit provides a reasonable basis for our opinion.
/s/ Marcum llp
Marcum llp
We have served as the Company’s auditor since 2023.
New York, NY
March 27, 2024
47
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 sheet of SmartKem, Inc. (the “Company”) as of December 31, 2022, the related consolidated statements of operations and comprehensive loss, stockholders’ equity, and cash flows for the year 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 the results of its operations and its cash flows for the year 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 audit. 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 audit 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 audit 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 audit 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 audit 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 audit provides a reasonable basis for our opinion.
/s/ BDO LLP
BDO LLP
We have served as the Company's auditor from 2020 through to 2023.
Manchester, United Kingdom
March 30, 2023, except for the effects of the reverse stock split as described in Notes 2 and 8, which is dated March 27, 2024
48
Table of Contents
SMARTKEM, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except number of shares and per share data)
December 31, December 31,
Assets
Current assets
Cash and cash equivalents $ 8,836 $ 4,235
Accounts receivable 268 30
Research and development tax credit receivable 610 1,121
Prepaid expenses and other current assets 811 1,056
Property, plant and equipment, net 455 602
Right-of-use assets, net 285 475
Other assets, non-current 7 6
Liabilities and stockholders’ equity
Current liabilities
Accounts payable and accrued expenses $ 1,178 $ 931
Lease liabilities, current 230 206
Income tax payable — 22
Other current liabilities 360 244
Total current liabilities 1,768 1,403
Lease liabilities, non-current 19 239
Warrant liability 1,372 —
Commitments and contingencies (Note 7) — —
Stockholders’ equity:
Accumulated other comprehensive loss (1,578) (483)
Total stockholders' equity 8,113 5,883
Total liabilities and stockholders’ equity $ 11,272 $ 7,525
The accompanying notes are an integral part of these consolidated financial statements.
49
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,
Revenue $ 27 $ 40
Cost of revenue 23 33
Gross profit 4 7
Other operating income 836 1,172
Operating expenses
Research and development 5,556 5,802
Selling, general and administrative 5,188 5,071
Loss on foreign currency transactions 87 —
Loss from operations (9,991) (9,694)
Non-operating income/(expense)
Gain/(loss) on foreign currency transactions 1,213 (1,782)
Transaction costs allocable to warrants (198) —
Change in fair value of the warrant liability, net 465 —
Interest income 12 5
Total non-operating income/(expense) 1,492 (1,777)
Loss before income taxes (8,499) (11,471)
Income tax expense — (24)
Other comprehensive loss:
Foreign currency translation (1,095) 880
Total comprehensive loss $ (9,594) $ (10,615)
Basic and diluted net loss per common share * $ (6.32) $ (13.88)
The accompanying notes are an integral part of these consolidated financial statements.
50
Table of Contents
SMARTKEM, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity
(in thousands, except share data)
Accumulated
Preferred Stock Common stock * Additional other Total
Shares Amount Shares Amount capital income / (loss) deficit equity
Stock-based compensation expense — — — — 717 — — 717
Issuance of common stock to vendor — — 2,937 — 55 — — 55
Exercise of warrants into common stock — — 71,786 — 25 — — 25
Net loss — — — — — — (8,499) (8,499)
Accumulated
Preferred Stock Common stock * Additional other Total
Shares Amount Shares Amount capital income / (loss) deficit equity
Stock-based compensation expense — — — — 488 — — 488
Issuance of common stock to vendor — — 12,308 — 658 — — 658
Reverse stock split rounding — — (3) — — — — —
Foreign currency translation adjustment — — — — — 880 — 880
Net loss — — — — — — (11,495) (11,495)
The accompanying notes are an integral part of these consolidated financial statements.
51
Table of Contents
SMARTKEM, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
Year Ended December 31,
Cash flow from operating activities:
Stock-based compensation expense 717 488
Issuance of common stock to vendor 55 391
Right-of-use asset amortization 263 264
Gain/(loss) on foreign currency transactions (1,120) 1,782
Transaction costs allocable to warrants 198 —
Change in fair value of the warrant liability, net (465) —
Change in operating assets and liabilities:
Accounts receivable (231) (32)
Research and development tax credit receivable 562 (213)
Prepaid expenses and other current assets 70 (42)
Accounts payable and accrued expenses 459 (385)
Lease liabilities (266) (265)
Income tax payable (23) 22
Other current liabilities 98 238
Net cash used in operating activities (8,037) (9,049)
Cash flows from investing activities:
Purchases of property, plant and equipment (18) (79)
Net cash used by investing activities (18) (79)
Cash flow from financing activities:
Proceeds from the issuance of warrants in private placement 1,763 —
Proceeds from the issuance of common stock in private placement — 2,000
Payment of issuance costs (1,483) (170)
Proceeds from the exercise of warrants 25 —
Net cash provided by financing activities 12,691 1,830
Effect of exchange rate changes on cash (35) (693)
Initial classification of fair value of warrants $ 1,837 $ —
Right-of-use asset and lease liability additions $ 50 $ 583
Issuance of common shares for consulting services $ — $ 633
The accompanying notes are an integral part of these consolidated financial statements.
52
Table of Contents
SMARTKEM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
1. ORGANIZATION & 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”).
53
Table of Contents
SMARTKEM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Business
We are seeking to reshape the world of electronics with our disruptive organic thin-film transistors (OTFTs) that we believe have the potential to drive the next generation of displays. Our patented TRUFLEX® semiconductor and dielectric inks, or electronic polymers, are used to make a new type of transistor that we believe have the capability to revolutionize the display industry. Our inks enable low temperature printing processes that are compatible with existing manufacturing infrastructure to deliver low-cost displays that outperform existing technologies. Our electronic polymer platform can be used in a range of display technologies including microLED, miniLED and AMOLED displays for next generation televisions, laptops, augmented reality (AR) and virtual reality (VR) headsets, smartwatches and smartphones.
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, 2023, and 2022, respectively were deemed to be immaterial to the consolidated financial statements.
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.
Reclassification
Certain accounts in the prior period consolidated financial statements have been reclassified to conform to the presentation of the current year consolidated financial statements. These reclassifications had no effect on the previously reported operating results.
Reverse Stock Split
All share numbers and per share amounts presented in these financial statements, including these footnotes reflect a one-for-thirty-five (1:35) reverse stock split effected on September 21, 2023 (see also Note 8).
Liquidity
As of December 31, 2023, we have incurred recurring losses including net losses of $8.5 million and $11.5 million for the years ended December 31, 2023, and 2022, respectively. We anticipate operating losses to continue for the
54
Table of Contents
SMARTKEM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
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.
In June 2023 the Company raised $14.2 million through two closings of a private placement of Preferred Stock and Warrants. Net proceeds after related expenses was $12.7 million. In addition, the company has also gone through various cost cutting measures such as lowering personnel costs through a reduction in force, reduced spending on professional service fees and reduced our lease and related utility costs by consolidating office and lab space. All of these actions together have alleviated the going concern that was reported in 2022.
We expect that our cash and cash equivalents of $8.8 million as of December 31, 2023, will be sufficient to fund our operating expenses and capital expenditure requirements through the end of April 2025. 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.
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.
Basis of Consolidation
The consolidated financial statements include the accounts of SmartKem, Inc. and its wholly-owned subsidiary, 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.
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, and the fair value of warrant liability. These estimates and assumptions are based on current facts, historical experience and various other factors believed
55
Table of Contents
SMARTKEM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of expenses that are not readily apparent from other sources. Due to the uncertainty of factors surrounding the estimates or judgments used in the preparation of the consolidated financial statements, actual results may materially vary from these estimates.
Certain Risk and Uncertainties
The Company’s activities are subject to significant risks and uncertainties including the risk of failure to secure additional funding to properly execute the Company’s business plan. The Company is subject to risks that are common to companies in the growth stage, including, but not limited to, development by the Company or its competitors of new technological innovations, dependence on key personnel, reliance on third party manufacturers, protection of proprietary 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, 2023 and 2022, 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 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 credit losses would be required. There was no allowance for credit losses recorded as of December 31, 2023 and 2022.
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.
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.
56
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, 2023, and 2022, Company’s management believed that no revision to the remaining useful lives or impairment of the Company’s long-lived assets was required.
Fair Value of Financial Instruments
ASC 820, Fair Value Measurements, provides guidance on the development and disclosure of fair value measurements. Under this accounting guidance, fair value is defined as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability.
The accounting guidance classifies fair value measurements in one of the following three categories for disclosure purposes:
Level 1: Quoted prices in active markets for identical assets or liabilities.
Level 2: Inputs other than Level 1 prices for similar assets or liabilities that are directly or indirectly observable in the marketplace.
Level 3: Unobservable inputs which are supported by little, or no market activity and values determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant judgment or estimation.
Fair value measurements discussed herein are based upon certain market assumptions and pertinent information available to management as of and during the years ended December 31, 2023, and 2022. The carrying value of the Company’s cash, accounts receivable, other receivables, and accounts payable approximate fair value because of the short-term maturity of these financial instruments.
Warrants
The accounting treatment of warrants issued is determined pursuant to the guidance provided by ASC 480, Distinguishing Liabilities from Equity, and ASC 815-40, Contracts in Entity's Own Equity, 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 assessed its warrants in accordance with this guidance, under which warrants that do not meet the criteria for equity treatment and must be recorded as liabilities. Accordingly, the Company will classify those warrants as liabilities at their fair value and adjusts the warrants to fair value in respect of each reporting period. This liability is subject to re-measurement at each balance sheet date and any change in fair value is recognized in the statements of operations.
57
Table of Contents
SMARTKEM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Issuance Costs
The Company assessed the issuance cost in connection with the issuance of an equity offering. ASC 340-10-S99-1 and SEC Staff Accounting Bulletin (“SAB”) Topic 5A, Expenses of Offering, states that specific incremental costs directly attributable to a proposed or actual offering of equity securities may properly be deferred and charged against the gross proceeds of the offering. Analogizing to that guidance, specific incremental costs directly attributable to the issuance of an equity contract to be classified in equity should generally be recorded as a reduction in equity. However, issuance costs for equity contracts that are classified as a liability should be expensed immediately. The issuance costs are allocated to the equity and liability components of the underlying transaction on a basis of the allocated fair value of the gross proceeds in the overall transactions.
Direct and incremental legal and accounting costs associated with the Company’s issuance of common stock, preferred 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, 2023, we recorded $1.5 million of offering costs of which $1.3 million were recorded in additional paid-in capital and $0.2 million were recorded as non-operating expenses and for the year ended December 31, 2022, $170 thousand of offering costs were recorded in additional paid-in capital.
Non-retirement Post-employment Benefits
The company records employee severance benefits as non-retirement post-employment benefits that are accounted for under the guidance of ASC 712-10 Compensation - Nonretirement Postemployment Benefits. 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, 2023 and 2022. 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 inception date of the lease agreement in determining the present value of lease payments.
Revenue
The Company applies the provisions of ASC 606, Revenue from Contracts with Customers. The Company recognizes revenue under the core principle to depict the transfer of control to the Company’s customers in an amount reflecting the consideration the Company expects to be entitled to. In order to achieve that core principle, the Company applies the following five step approach: (1) identify the contract with a customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contact and (5) recognize revenue when a performance obligation is satisfied.
The Company’s current contracts with customers do not contain significant estimates or judgments. All of the Company’s revenue contains a single performance obligation that is recognized upon fulfilment of the sales order.
The Company derives its revenues primarily from sales of TRUFLEX® inks and of demonstrator units to customers evaluating organic semiconductor technology. The transaction price is stated in each customer agreement and is
58
Table of Contents
SMARTKEM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
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 collaboration agreements during 2023. The business arrangements between the two parties are not accounted for as a Collaborative Arrangement, as defined within the guidance under ASC 808, Collaborative Arrangement, 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 parties are a vendor and not a customer, as defined within the guidance under ASC 606, as the other parties 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 parties 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.
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.
The Company has applied the guidance of IAS 20, Accounting for Government Grants and Disclosure of Government Assistance to account for grants and recognition of the other operating income related to the grant. The government
59
Table of Contents
SMARTKEM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
grant is recognized only when there is reasonable assurance that a) the Company will comply with any conditions attached to the grant and, (b) the grant will be received. The grant is recognized as income over the period necessary to match the related costs, for which the grant is intended to compensated, on a systematic basis. A grant receivable as compensation for costs already incurred or for immediate financial support, with no future related costs, is recognized as other operating income in the period in which it is receivable.
For the year ended December 31, 2023 and 2022, the Company recorded grant income and research & development tax credits of $836 thousand and $1,172 thousand, respectively, which are recorded as other operating income in the accompanying consolidated statements of operations. As of December 31, 2023 and 2022, the Company had receivables related to research & development tax credits for payments not yet received of $610 thousand and $1,121 thousand, respectively and receivables related to a government grants of $160 thousand as of December 31, 2023. The Company had no receivables related to government grants as of December 31, 2022.
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;
● 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;
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 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.
60
Table of Contents
SMARTKEM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Non-cash stock-based compensation expense for the year ended December 31, 2023 and 2022 were $0.7 million and $0.5 million, respectively (see also Note 9).
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 using a simplified method, 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, 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, 2023 and 2022. 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, 2023, and 2022, there were no material uncertain tax positions.
61
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. From time to time, the Company may be party to certain litigation and disputes arising in the normal course of business. As of December 31, 2023, the Company is not a party to any litigation or disputes.
Segment Information
The Company has determined that it operates and reports in onesegment, 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).
As of December 31, 2023, the Company had 61,587 pre-funded common stock warrants and 769,826 Class B Warrants outstanding and exercisable. As the pre-funded common stock warrants and Class B Warrants are exercisable for $0.35, 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 following potentially dilutive securities have been excluded from the computation of diluted weighted average shares outstanding as they would be anti-dilutive:
December 31,
Assumed conversion of preferred stock 1,573,226 —
Recent Accounting Pronouncements
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
62
Table of Contents
SMARTKEM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
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 filers. However, the standard was 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. The adoption of this guidance did not have a material impact in the interim condensed consolidated financial statements of the Company.
In November 2023, the FASB issued Accounting Standards Update (ASU) No. 2023-07, Segment Reporting (Topic 280), Improvements to Reportable Segment Disclosures which will require companies to disclose significant segment expenses that are regularly provided to the chief operating decision maker ("CODM"). The pronouncement is effective for annual filings for the year ended December 31, 2024. The Company is still assessing the impact of the adoption of this standard but does not expect it to have a material impact on its results of operations, financial position or cash flows.
On December 14, 2023, the FASB issued ASU 2023-09, Improvements to Income Tax Disclosures which applies to all entities subject to income taxes. The standard requires disaggregated information about a reporting entity’s effective tax rate reconciliation as well as information on income taxes paid. The standard is intended to provide more detailed income tax disclosures. For public business entities (PBEs), the new requirements will be effective for annual periods beginning after December 15, 2024. The guidance will be applied on a prospective basis with the option to apply the standard retrospectively. The Company is still assessing the impact of the adoption of this standard but does not expect it to have a material impact on its results of operations, financial position or cash flows.
The OECD reached an agreement among various countries to implement a minimum 15% tax rate on certain multinational enterprises, commonly referred to as Pillar Two. Many countries continue to announce changes in their tax laws and regulations based on Pillar Two Proposals. We are continuing to evaluate the impact of these proposed and enacted legislative changes as new guidance becomes available. Given the numerous proposed changes in law and uncertainty regarding such proposed changes, the impact cannot be determined at this time.
63
Table of Contents
SMARTKEM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
3. PREPAID EXPENSES AND OTHER CURRENT ASSETS:
Prepaid expenses and other current assets consist of the following:
December 31, December 31,
Prepaid facility costs $ 101 $ 106
Prepaid professional service fees 68 339
Research grant receivable 160 —
Prepaid software licenses 24 22
Other receivable and other prepaid expenses 80 36
Total prepaid expenses and other current assets $ 811 $ 1,056
4. PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment consist of the following:
December 31, December 31,
Furniture and fixtures 108 218
Computer hardware and software 24 24
Less: Accumulated depreciation (1,261) (1,118)
Property, plant and equipment, net $ 455 $ 602
Depreciation expense was $145 thousand and $198 thousand for the year ended December 31, 2023 and 2022, 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,
Accounts payable $ 355 $ 250
Accrued expenses – lab refurbishments — 117
Accrued expenses – technical fees 91 130
Accrued expenses – audit & accounting fees 182 179
Accrued expenses – other 175 44
Payroll liabilities 375 211
Total accounts payable and accrued expenses $ 1,178 $ 931
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.
64
Table of Contents
SMARTKEM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements