SmartKem, Inc. Fair Value Disclosure

12.   FAIR VALUE MEASUREMENTS:

The table below presents activity within Level 3 of the fair value hierarchy, our liabilities carried at fair value for the year ended December 31, 2024:

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As disclosed in Note 8 of the Company’s consolidated financial statements, the Company allocated part of the proceeds of private placement of the Company’s Series A-1 Preferred Stock and Series A-2 Preferred Stock to warrant liability issued in connection with the transaction. The valuations of the warrants were determined using option pricing models. These models use 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 used an expected volatility based on historical common stock volatility of our peers. The Company initially accounted for the warrants as derivative instruments in accordance with ASC 815, adjusting the fair value at the end of each reporting period. Upon the Company’s uplisting to the Nasdaq Capital Market on May 31, 2024, certain provisions within the warrant agreements were no longer in effect. As a result, the warrants are accounted for as an equity instrument, with the balance of the derivative liability on May 31, 2024 being transferred to Additional Paid-In Capital.

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The fair value of the common stock warrants at May 30, 2024 and December 31, 2023 was determined by using option pricing models assuming the following:

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Additionally, the Company had determined that the warrant liability should be classified within Level 3 of the fair-value hierarchy by evaluating each input for the option pricing models against the fair-value hierarchy criteria and using the lowest level of input as the basis for the fair-value classification as called for in ASC 820. There are six inputs: closing price of SmartKem stock on the day of evaluation; the exercise price of the warrants; the remaining term of the warrants; the volatility of the Company’s stock over that term; annual rate of dividends; and the risk-free rate of return. Of those inputs, the exercise price of the warrants and the remaining term are readily observable in the warrant agreements. The annual rate of dividends is based on the Company’s historical practice of not granting dividends. The closing price of SmartKem stock would fall under Level 1 of the fair-value hierarchy as it is a quoted price in an active market (ASC 820-10). The risk-free rate of return is a Level 2 input as defined in ASC 820-10, while the historical volatility is a Level 3 input as defined in ASC 820. Since the lowest level input is a Level 3, the Company determined the warrant liability is most appropriately classified within Level 3 of the fair value hierarchy.

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There were no assets or liabilities measured at fair value as of December 31, 2024. The following tables present information about the Company’s financial assets and liabilities that have been measured at fair value as of  December 31, 2023 and indicate the fair value hierarchy of the valuation inputs utilized to determine such fair value.

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