SmartKem, Inc. 10-Q

Item 1. Financial Statements SMARTKEM, INC. AND SUBSIDIARIES Condensed Consolidated Balance Sheets (Unaudited) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ June 30, ​ December 31, ​ 2021 2020 ASSETS ​ ​ ​ ​ ​ ​ ​ ​ ​ Current assets: ​ ​ Cash and cash equivalents ​ $ 16,430,719 ​ $ 763,814 Accounts receivable ​ — ​ 18,385 Research and development tax credit receivable ​ 1,490,253 ​ 981,568 Prepaid expenses and other current assets ​ 1,204,262 ​ 259,046 Total current assets ​ 19,125,234 ​ 2,022,813 Property, plant equipment, net of accumulated depreciation of $ 1,014,063 and $ 908,238 ​ 715,068 ​ 682,325 Right-of-use assets, net ​ 231,967 ​ 236,123 Other assets ​ 9,574 ​ 8,408 Total assets ​ $ 20,081,843 ​ $ 2,949,669 ​ ​ ​ ​ ​ ​ ​ LIABILITIES AND STOCKHOLDERS' EQUITY ​ ​ ​ ​ ​ ​ ​ ​ ​ Accounts payable and accrued expenses ​ $ 1,307,662 ​ $ 860,633 Current lease liabilities ​ 176,694 ​ 217,313 Total current liabilities ​ 1,484,356 ​ 1,077,946 Non-current lease liabilities ​ 33,548 ​ 20,475 Total liabilities ​ 1,517,904 ​ 1,098,421 ​ ​ ​ ​ ​ ​ ​ Stockholders’ Equity: ​ ​ Common stock, par value $ 0.0001 per share, 300,000,000 shares authorized, 25,462,000 and 13,627,887 shares issued and outstanding , at June 30, 2021 and December 31, 2020, respectively* ​ 2,547 ​ 1,363 Additional paid-in capital ​ 89,721,913 ​ 61,275,841 Accumulated other comprehensive loss ​ ( 1,447,191 ) ​ ( 1,479,841 ) Accumulated deficit ​ ( 69,713,330 ) ​ ( 57,946,115 ) Total Stockholders’ equity ​ 18,563,939 ​ 1,851,248 ​ ​ ​ ​ ​ ​ ​ Total Liabilities and Stockholders’ Equity ​ $ 20,081,843 ​ $ 2,949,669 * Please refer to Note 1 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. ​ 3 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Operations and Comprehensive Loss (Unaudited) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Three Months Ended June 30, ​ Six Months Ended June 30, ​ 2021 2020 2021 2020 Revenue ​ $ — ​ $ — ​ $ — ​ $ 20,770 Cost of revenue ​ — ​ — ​ — ​ 12,348 Gross profit ​ — ​ — ​ — ​ 8,422 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Other operating income ​ 255,648 ​ 186,119 ​ 688,171 ​ 377,996 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Operating Expenses: ​ ​ ​ ​ Research and development ​ 1,355,167 ​ 998,985 ​ 5,368,511 ​ 2,110,638 Selling, general and administrative ​ 1,345,248 ​ 242,776 ​ 5,328,073 ​ 768,887 Transaction expenses ​ 15,232 ​ — ​ 1,329,271 ​ — Total operating expenses ​ 2,715,647 ​ 1,241,761 ​ 12,025,855 ​ 2,879,525 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Loss from operations ​ ( 2,459,999 ) ​ ( 1,055,642 ) ​ ( 11,337,684 ) ​ ( 2,493,107 ) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Non-operating Income (Expense) ​ ​ ​ ​ Gain (loss) on foreign currency transactions ​ 57,230 ​ 148 ​ ( 412,853 ) ​ ( 1,418 ) Interest expense ​ — ​ — ​ ( 18,697 ) ​ ( 6,834,772 ) Interest income ​ 1,869 ​ 1,227 ​ 2,019 ​ 3,251 Change in fair value of derivative asset ​ — ​ — ​ — ​ ( 6,282,381 ) Loss on conversion of convertible notes payable ​ — ​ — ​ — ​ ( 5,469,825 ) Total non-operating income (expense) ​ 59,099 ​ 1,375 ​ ( 429,531 ) ​ ( 18,585,145 ) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Loss before income taxes ​ ( 2,400,900 ) ​ ( 1,054,267 ) ​ ( 11,767,215 ) ​ ( 21,078,252 ) Income tax expense ​ — ​ — ​ — ​ — Net loss ​ $ ( 2,400,900 ) ​ $ ( 1,054,267 ) ​ $ ( 11,767,215 ) ​ $ ( 21,078,252 ) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Net loss ​ $ ( 2,400,900 ) ​ $ ( 1,054,267 ) ​ $ ( 11,767,215 ) ​ $ ( 21,078,252 ) Other comprehensive loss: ​ ​ ​ ​ Foreign currency translation ​ 15,170 ​ ( 21,866 ) ​ 32,650 ​ ( 561,353 ) Total comprehensive loss ​ $ ( 2,385,730 ) ​ $ ( 1,076,133 ) ​ $ ( 11,734,565 ) ​ $ ( 21,639,605 ) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Basic & dilutive net loss per common share ​ $ ( 0.09 ) ​ $ ( 0.08 ) ​ $ ( 0.52 ) ​ $ ( 1.80 ) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Basic & dilutive weighted average shares outstanding ​ ​ 27,066,385 ​ ​ 13,447,057 ​ ​ 22,733,033 ​ ​ 12,022,647 ​ The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. ​ ​ 4 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Stockholders’ Equity (Unaudited) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Accumulated ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Additional ​ Other ​ ​ ​ ​ ​ ​ ​ ​ Common stock ​ Paid-in ​ Comprehensive ​ Accumulated ​ Stockholders’ ​ Shares Amount Capital Loss Deficit Equity (Deficit) Balance at January 1, 2020 2,183,885 ​ $ 218 ​ $ 30,925,922 ​ $ ( 1,195,628 ) ​ $ ( 34,812,947 ) ​ $ ( 5,082,435 ) Issuance of common stock 2,368,047 ​ 237 ​ 4,278,693 ​ - ​ - ​ 4,278,930 Conversion of notes and interest 8,895,125 ​ 890 ​ 25,757,768 ​ - ​ - ​ 25,758,658 Foreign currency translation adjustment - ​ - ​ - ​ ( 539,487 ) ​ - ​ ( 539,487 ) Net loss - ​ - ​ - ​ - ​ ( 20,023,985 ) ​ ( 20,023,985 ) Balance at March 31, 2020 ​ 13,447,057 ​ ​ 1,345 ​ ​ 60,962,383 ​ ​ ( 1,735,115 ) ​ ​ ( 54,836,932 ) ​ ​ 4,391,681 Foreign currency translation adjustment ​ - ​ ​ - ​ ​ - ​ ​ ( 21,866 ) ​ ​ - ​ ​ ( 21,866 ) Net loss ​ - ​ ​ - ​ ​ - ​ ​ - ​ ​ ( 1,054,267 ) ​ ​ ( 1,054,267 ) Balance at June 30, 2020 13,447,057 ​ $ 1,345 ​ $ 60,962,383 ​ $ ( 1,756,981 ) ​ $ ( 55,891,199 ) ​ $ 3,315,548 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ 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 ​ $ 1,363 ​ $ 61,275,841 ​ $ ( 1,479,841 ) ​ $ ( 57,946,115 ) ​ $ 1,851,248 Issuance of common shares due to exercise of stock-options 1,404,813 ​ 141 ​ 19,402 ​ - ​ - ​ 19,543 Stock-based compensation expense - ​ - ​ 6,019,517 ​ - ​ - ​ 6,019,517 Repurchase of common stock ( 2,307,700 ) ​ ( 231 ) ​ 230 ​ - ​ - ​ ( 1 ) Effect of reverse capitalization 2,500,000 ​ 250 ​ ( 250 ) ​ - ​ - ​ - Issuance of common shares to vendor 50,000 ​ 5 ​ 98,995 ​ - ​ - ​ 99,000 Issuance of common stock and warrants in private placement 10,162,000 ​ 1,016 ​ 24,637,304 ​ - ​ - ​ 24,638,320 Issuance costs related to common stock and warrants in private placement - ​ - ​ ( 2,454,324 ) ​ - ​ - ​ ( 2,454,324 ) Foreign currency translation adjustment - ​ - ​ - ​ 17,480 ​ - ​ 17,480 Net loss - ​ - ​ - ​ - ​ ( 9,366,315 ) ​ ( 9,366,315 ) Balance at March 31, 2021 ​ 25,437,000 ​ ​ 2,544 ​ ​ 89,596,715 ​ ​ ( 1,462,361 ) ​ ​ ( 67,312,430 ) ​ ​ 20,824,468 Stock-based compensation expense - ​ - ​ 75,201 ​ - ​ - ​ 75,201 Issuance of common shares to vendor 25,000 ​ 3 ​ 49,997 ​ - ​ - ​ 50,000 Foreign currency translation adjustment ​ - ​ ​ - ​ ​ - ​ ​ 15,170 ​ ​ - ​ ​ 15,170 Net loss ​ - ​ ​ - ​ ​ - ​ ​ - ​ ​ ( 2,400,900 ) ​ ​ ( 2,400,900 ) Balance at June 30, 2021 ​ 25,462,000 ​ $ 2,547 ​ $ 89,721,913 ​ $ ( 1,447,191 ) ​ $ ( 69,713,330 ) ​ $ 18,563,939 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. ​ ​ 5 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Cash Flows (Unaudited) ​ ​ ​ ​ ​ ​ ​ ​ Six Months Ended June 30, ​ 2021 2020 Cash flows from operating activities: ​ ​ Net loss $ ( 11,767,215 ) ​ $ ( 21,078,252 ) Adjustments to reconcile net loss to net cash used in operating activities: ​ Depreciation 95,188 ​ 98,494 Common shares issued to vendor for services 107,333 ​ — Amortization of right of use asset 96,135 ​ 88,444 Stock-based compensation ​ 6,094,718 ​ ​ — Non-cash interest expense — ​ 6,834,772 Change in fair value of embedded conversion feature — ​ 6,282,381 Loss on conversion of convertible notes payable — ​ 5,469,825 Change in operating assets and liabilities: ​ ​ Accounts receivable, net 18,562 ​ ( 545 ) Research & development tax credit receivable ( 498,909 ) ​ ( 366,162 ) Prepaid expenses and other current assets ( 901,044 ) ​ ( 44,037 ) Accounts payable and accrued expenses 435,473 ​ ( 41,077 ) Lease liabilities ( 119,709 ) ​ ( 79,201 ) Other assets ( 1,069 ) ​ — Net cash used in operating activities ( 6,440,537 ) ​ ( 2,835,358 ) ​ ​ ​ ​ ​ ​ Cash flows from investing activities: ​ Purchases of property, plant and equipment ( 120,568 ) ​ ( 88,359 ) Net cash used by investing activities ( 120,568 ) ​ ( 88,359 ) ​ ​ ​ ​ ​ ​ Cash flows from financing activities: ​ Proceeds from Credit Facility Loan Payable 737,898 ​ — Repayment of Credit Facility Loan Payable ​ ( 737,898 ) ​ ​ — Proceeds from the issuance of common stock ​ — ​ ​ 4,278,930 Proceeds from the issuance of common stock and warrants in private placement 24,638,320 ​ ​ — Payment of issuance costs ( 2,454,324 ) ​ ​ — Proceeds from the exercise of stock options 19,543 ​ — Net cash provided by financing activities 22,203,539 ​ 4,278,930 ​ ​ ​ ​ ​ ​ Effect of exchange rate changes on cash 24,471 ​ ( 197,110 ) ​ ​ ​ ​ ​ ​ Net change in cash 15,642,434 ​ 1,355,213 ​ ​ ​ ​ ​ ​ Cash, beginning of period 763,814 ​ 411,936 Cash, end of period $ 16,430,719 ​ $ 1,570,039 ​ ​ ​ ​ ​ ​ Supplemental disclosure of cash and non-cash investing and financing activities ​ Cash paid for income taxes $ — ​ $ — Cash paid for interest $ 18,697 ​ $ — Right of use asset and lease liability additions $ 86,357 ​ $ — Issuance of common shares for consulting services $ 50,000 ​ $ — Conversion of debt and accrued interest into common shares $ — ​ $ 25,758,658 ​ The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. ​ ​ 6 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) ​ 1. BUSINESS AND LIQUIDITY 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 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. ​ 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”). ​ 7 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) ​ Business SmartKem, Inc. is a pioneer in the manufacture of Application Specific Organic Materials for organic thin-film transistor (OTFT) backplanes that power the next generation of flexible electronics, displays, sensors and logic. SmartKem’s unique TRUFLEX® technology allows inks to be deposited at a low temperature on low-cost substrates, resulting in transistor stacks that are flexible, bendable, wearable, and lightweight. These can be used in a number of next generation display technologies including bendable smartphone displays, curved automotive displays, full color e-paper displays, wearables, fingerprint sensors, printed biosensors and logic. The Company’s commercial success depends in part on the ability to obtain and maintain intellectual property protection for the inks, processes and know-how comprising its TRUFLEX® technology, to operate without infringing the proprietary rights of others, and to prevent others from infringing on its proprietary rights. The Company has established a portfolio relating to its TRUFLEX® technology. The Company’s portfolio currently includes 124 issued patents, 11 pending patent applications, 25 future national applications, and more than 30 trade secrets. The patents cover the active semiconductor materials, deposition process and formulations comprising the Company’s TRUFLEX® technology. Liquidity and Going Concern The accompanying 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 normal course of business. The Company has financed its activities principally from the issuance of its equity securities. 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 three and six months ended June 30, 2021 were deemed to be immaterial to the financial statements. The Company anticipates there may be additional costs relating to the Pandemic incurred in the upcoming months that will be attributable to fiscal year 2021 and thereafter. These costs are not expected to be material. The Company has incurred substantial and negative cash flows from operations in every fiscal period since inception. For three and six months ended June 30, 2021, the Company incurred a net loss of $ 2.4 million and $ 11.8 million, respectively, and used $ 6.4 million in cash to fund operations for the six months ended June 30, 2021 and had an accumulated deficit of $ 69.7 million as of June 30, 2021. The Company’s cash as of June 30, 2021 was $ 16.4 million. Management believes that the existing cash at June 30, 2021 will be sufficient to fund operations for at least the next twelve months following the issuance of these unaudited condensed 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. ​ 8 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) ​ 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Basis for Presentation These unaudited 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. 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 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, 2020. The accompanying 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 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. Basis of Consolidation The 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 dissolution of the Company's wholly-owned subsidiary, SmartKem Delaware Inc., was authorized by the Board of Directors and Stockholders on April 28, 2021. 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 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 condensed consolidated financial statements relates to the valuation of common share, fair value of share options, fair value of embedded conversion features in the convertible notes, and the valuation allowance of deferred tax assets. These estimates and assumptions are based on current facts, historical experience and various other factors believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of expenses that are not readily apparent from other sources. Due to the uncertainty of factors surrounding the estimates or judgments used in the preparation of the 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 9 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) ​ 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 demonstration 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 June 30, 2021 and December 31, 2020, the Company did no t have any cash equivalents. Accounts Receivable Accounts receivable are stated at the amount the Company expects to collect and do not bear interest. The Company considers the following factors when determining the collectability of specific customer accounts: customer 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 June 30, 2021 and December 31, 2020. Concentrations of Credit Risk Financial instruments that potentially subject the Company to significant concentration of credit risk consist primarily of cash and cash equivalents and accounts receivable. Periodically, the Company maintains deposits in financial institutions in excess of government insured limits. Management believes that the Company is not exposed to significant credit risk as the Company’s deposits are held at financial institutions that management believes to be of high credit quality and the Company has not experienced any losses in these deposits. Property, Plant and Equipment Property, plant and equipment is stated at cost, less accumulated depreciation. Maintenance and repairs are expensed when incurred. Additions and improvements that extend the economic useful life of the asset are capitalized and depreciated over the remaining useful lives of the assets. The cost and accumulated depreciation of assets sold or retired are removed from the respective accounts, and any resulting gain or loss is reflected in current earnings. Depreciation and amortization are provided using the accelerated declining balance method in amounts considered to be sufficient to amortize the cost of the assets to operations over their estimated useful lives. Property, plant and equipment is depreciated at 25 percent of net book value on an annual basis, resulting in an estimated useful life of approximately 15 years . Impairment of Long-Lived Assets Management continually evaluates whether events or changes in circumstances might indicate that the remaining estimated useful life of long-lived assets may warrant revision, or that the remaining balance may not be recoverable. When factors indicate that long-lived assets should be evaluated for possible impairment, the Company uses an estimate 10 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) ​ 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 June 30, 2021 and December 31, 2020, Company’s management believed that no revision to the remaining useful lives or impairment of the Company’s long-lived assets was required. Derivative Asset for Embedded Conversion Features The Company does not use derivative instruments to hedge exposures to cash flow, market, or foreign currency risks. The Company evaluates convertible notes to determine if those contracts or embedded components of those contracts qualify as derivatives to be accounted for separately. In circumstances where the embedded conversion option in a convertible instrument is required to be bifurcated and there are also other embedded derivative instruments in the convertible instrument that are required to be bifurcated, the bifurcated derivative instruments are accounted for as a single, compound derivative instrument. The result of this accounting treatment is that the fair value of the embedded derivative is recorded as a liability and marked-to-market each balance sheet date, with the change in fair value recorded in the statements of operations as other income or expense. Upon conversion or exercise of a derivative instrument, the instrument is marked to fair value at the conversion date and then that fair value is reclassified to equity. The fair value of the embedded conversion features are estimated using a Monte Carlo simulation model, in which possible outcomes and their values are simulated repeatedly and randomly. Under the Monte Carlo method the Company estimated the fair value of the convertible notes conversion feature at the time of issuance and subsequent remeasurement dates, utilizing the with-and without method, where the value of the derivative feature is the difference in values between a note simulated with the embedded conversion feature and the value of the same note simulated without the embedded conversion feature. Estimating fair values of embedded conversion features requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. Fair Value of Financial Instruments ASC 820, Fair Value Measurements , provides guidance on the development and disclosure of fair value measurements. Under this accounting guidance, fair value is defined as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. The accounting guidance classifies fair value measurements in one of the following three categories for disclosure purposes: Level 1: Quoted prices in active markets for identical assets or liabilities. Level 2: Inputs other than Level 1 prices for similar assets or liabilities that are directly or indirectly observable in the marketplace. 11 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) ​ 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 for three and six months ended June 30, 2021 and 2020. The carrying value of the Company’s cash, accounts receivable, other receivables, prepaid expenses and other current assets, accounts payable and accrued expenses approximate fair value because of the short-term maturity of these financial instruments. The carrying value of derivative asset is displayed at fair value. See Note 8 for additional information regarding fair value measurements. Convertible Notes The Company accounts for its convertible notes in accordance with ASC 470-20, Debt with Conversion and Other Options (“ASC 470-20”), which requires the liability and equity components of convertible debt instruments to be separately accounted for in a manner that reflects the issuer’s nonconvertible debt borrowing rate. Debt discount created by the bifurcation of embedded feature in the convertible notes are reflected as a reduction to the related debt liability. The discount is amortized to interest expense over the term of the debt using the effective-interest method. Warrants The accounting treatment of warrants issued is determined pursuant to the guidance provided by ASC 480, Distinguishing Liabilities from Equity , and ASC 815, Derivatives and Hedging , as applicable. Each feature of a freestanding financial 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 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 June 30, 2021 and December 31, 2020. 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. 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. 12 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) ​ 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. 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 condensed consolidated statements of operations and comprehensive loss. 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 June 30, 2021 and 2020, the Company recorded grant income and research & development tax credits of $ 255,648 and $ 186,119 , respectively, and $ 688,171 and $ 377,996 for the six months ended June 30, 2021 and 2020, respectively which are recorded as other operating income in the accompanying condensed consolidated statements of operations. As of June 30, 2021, and December 31, 2020, the Company had receivables related to research & development tax credits for payments not yet received of $ 1,490,253 and $ 981,568 , 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 13 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) ​ term, expected volatility, dividend yield, and risk-free interest rate. The assumptions used in calculating the fair value of stock-based awards represent management’s best estimates and involve inherent uncertainties and the application of management’s judgment. As a result, if factors change and management uses different assumptions, stock-based compensation expense could be materially different for future awards. The Company records forfeitures when they occur. Functional Currency and Operations Prior to the Exchange, SmartKem Limited’s (“the predecessor’s”) functional currency was the British Pound Sterling (“GBP”), and the consolidated financial statements were presented in United States dollars (“USD”). The predecessor’s functional currency was the respective local currency of the primary economic environment in which an entity’s operations are conducted. The predecessor translated the 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 June 30, 2021 and December 31, 2020, 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 June 30, 2021, 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. 14 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) ​ 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 consolidated balance sheet until 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. The deferred offering costs incurred as of December 31, 2020 were immaterial and no offering costs were capitalized. For the six months ended June 30, 2021 $ 2,454,324 of offering costs were recorded in additional paid-in capital. ​ 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 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 June 30, 2021, 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: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ June 30, ​ 2021 2020 Options ​ ​ 1,596,562 ​ ​ 116,084 Warrants ​ 985,533 ​ — Total ​ ​ 2,582,095 ​ ​ 116,084 ​ 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- 15 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) ​ 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. ​ 3. PREPAID EXPENSES AND OTHER CURRENT ASSETS: Prepaid expenses and other current assets consist of the following: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ June 30, ​ December 31, ​ 2021 2020 Prepaid rent ​ $ 93,585 ​ $ 65,254 Prepaid utilities ​ 30,639 ​ 30,271 Prepaid insurance ​ 674,771 ​ 40,414 Prepaid administrative expenses ​ 92,517 ​ 68,901 Prepaid consulting fees ​ ​ 124,581 ​ ​ — VAT receivable ​ 75,847 ​ 54,206 Other receivables ​ ​ 112,322 ​ ​ — Total prepaid expenses and other current assets ​ $ 1,204,262 ​ $ 259,046 ​ ​ As of June 30, 2021 and December 31, 2020, there was $ 239,531 and $ 0 , respectively, of non-current prepaid insurance related to directors’ and officers’ liability insurance that was included in the amounts above. ​ ​ 4. PROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment consist of the following: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ June 30, ​ December 31, ​ 2021 2020 Plant and equipment ​ $ 1,451,617 ​ $ 1,316,381 Furniture and fixtures ​ 250,797 ​ 247,785 Computer hardware and software ​ 26,717 ​ 26,397 ​ ​ 1,729,131 ​ 1,590,563 Less: Accumulated depreciation ​ ( 1,014,063 ) ​ ( 908,238 ) Property, plant and equipment, net ​ $ 715,068 ​ $ 682,325 ​ Depreciation expense was $ 47,383 and $ 48,339 for three months ended June 30, 2021 and 2020, respectively, and $ 95,188 and $ 98,494 for the six months ended June 30, 2021 and 2020, respectively, and is classified as research and development expense. ​ 16 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) ​ 5. ACCOUNTS PAYABLE AND ACCRUED EXPENSES: Accounts payable and accrued expenses consist of the following: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ June 30, ​ December 31, ​ 2021 2020 Accounts payable ​ $ 475,645 ​ $ 226,850 Accrued expenses – transaction costs ​ 68,755 ​ — Accrued expenses – lab refurbishments ​ 147,667 ​ 132,356 Accrued expenses – technical fees ​ 88,008 ​ 44,755 Accrued expenses – variable rent & utilities ​ 12,848 ​ 67,165 Accrued expenses – audit & accounting fees ​ 159,973 ​ 250,437 Accrued expenses – other ​ 30,432 ​ 5,879 Credit card liabilities ​ 14,054 ​ 6,308 Payroll liabilities ​ 310,280 ​ 126,883 Total accounts payable and accrued expenses ​ $ 1,307,662 ​ $ 860,633 ​ ​ 6. LEASES: The Company has operating leases consisting of office space, lab space, and equipment with remaining lease terms of 1 to 2 years , subject to certain renewal options as applicable. There was no sublease rental income for three and six months ended June 30, 2021 and 2020. The Company is not the lessor in any lease agreement, and no related party transactions for lease arrangements have occurred. ​ The table below presents certain information related to the lease costs for the Company’s operating and finance leases for the periods ended: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ For the Three Months Ended June 30, ​ For the Six Months Ended June 30, ​ 2021 2020 2021 2020 Operating lease cost ​ $ 52,121 ​ $ 42,850 ​ $ 99,192 ​ $ 87,025 Short-term lease cost ​ 12,611 ​ 2,014 ​ 25,947 ​ 13,111 Variable lease cost ​ 63,734 ​ 71,425 ​ 97,544 ​ 125,508 Total lease cost ​ $ 128,466 ​ $ 116,289 ​ $ 222,683 ​ $ 225,644 ​ For the three months ended June 30, 2021 and 2020, total lease cost of $ 8,912 and $ 8,929 , respectively, $ 16,091 and $ 20,606 for the six months ended June 30, 2021 and 2020, respectively, was recorded as selling, general and administrative in the statements of operations and other comprehensive loss. For the three months ended June 30, 2021 and 2020, total lease cost of $ 119,554 and $ 107,360 , respectively, and $ 206,592 and $ 205,038 for the six months ended June 30, 2021 and 2020, respectively, was recorded as research and development in the statements of operations and other comprehensive loss. ​ 17 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) ​ Right of use lease assets and lease liabilities for our operating leases were recorded in the consolidated balance sheet as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ June 30, ​ December 31, ​ 2021 2020 Assets ​ ​ ​ Operating lease right of use assets ​ $ 231,967 ​ $ 236,123 Total lease assets ​ $ 231,967 ​ $ 236,123 Liabilities ​ ​ Current liabilities: ​ ​ Operating lease liability – current portion ​ $ 176,694 ​ $ 217,313 Noncurrent liabilities: ​ ​ Operating lease liability, net of current portion ​ 33,548 ​ 20,475 Total lease liabilities ​ $ 210,242 ​ $ 237,788 ​ The Company had no right of use lease assets and lease liabilities for financing leases as of June 30, 2021 and December 31, 2020. The table below presents certain information related to the cash flows for the Company’s operating leases for the periods ended: ​ ​ ​ ​ ​ ​ ​ ​ ​ Six Months Ended June 30, ​ 2021 2020 Operating cash outflows from operating leases ​ $ 119,709 ​ $ 79,201 Supplemental non-cash amounts of operating lease liabilities arising from obtaining right of use assets ​ $ 86,357 ​ $ — ​ 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: ​ ​ ​ ​ ​ ​ June 30, ​ 2021 Weighted average remaining lease term (in years) – operating leases ​ 1.10 Weighted average discount rate – operating leases ​ 6.12 % ​ 18 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) ​ Undiscounted operating lease liabilities as of June 30, 2021, by year and in the aggregate, having non-cancelable lease terms in excess of one year were as follows: ​ ​ ​ ​ ​ ​ As of ​ ​ June 30, ​ ​ 2021 2021 ​ $ 145,860 2022 ​ 73,429 2023 ​ 8,571 2024 ​ — 2025 ​ — Thereafter ​ — Total undiscounted lease payments ​ 227,860 Less imputed interest ​ ( 17,618 ) Total net lease liabilities ​ $ 210,242 ​ ​ 7. CONVERTIBLE NOTES AND NOTES PAYABLE: Convertible Notes On January 24, 2020, a Qualified Financing Event (as defined below) occurred when the Company received cumulative investment proceeds in excess of $ 4,600,000 from the sale and issuance of common shares. The fair value of the Company’s common shares were $ 1.807011 per share. The 2018 BASF Venture Capital and Entrepreneurs Fund L.P. Notes (as defined below), 2018 Octopus Investment Limited Notes (as defined below), and the 2019 Octopus, EF, and Other Notes (as defined below) in the aggregate principal amount of $ 11,795,998 were converted into 8,159,977 of common shares (at the discounted price of $ 1.45 per share), and the related unpaid and accrued interest totaling $ 1,062,725 were also converted into 735,148 of A Ordinary common shares of the Company (at the discounted price of $ 1.45 per share). The Company recognized a loss on conversion of $ 5,469,825 for the six months ended June 30, 2020 related to the conversion of notes measured as the difference in carrying value of debt and accrued interest and the fair value of shares converted on the conversion date. As a result of the conversion, the Company also recognized the unamortized debt discount related to the beneficial conversion feature of $ 6,767,178 as interest expense for the six months ended June 30, 2020. For the six months ended June 30, 2020, the Company incurred an effective interest rate of 13.5 % relating to convertible notes. There were no convertible notes outstanding during the three months ended June 30, 2020 and the three and six months ended June 30, 2021. There was interest expense recognized based on the debt’s stated interest for the six months ended June 30, 2021 and 2020 of zero and $ 42,784 , respectively, relating to convertible notes. Additional interest expense related to the amortization of debt issuance cost was zero and $ 24,810 for the six months ended June 30, 2021 and 2020, respectively, for convertible notes. There was no interest expense or amortization of debt issuance cost recognized relating to convertible notes for the three months ended June 30, 2021 and 2020, Loss on the conversion of notes is included on the consolidated statements of operations and other comprehensive loss as loss on conversion of convertible notes payable. The amount displayed in the statements of operations and other comprehensive loss for the three months ended June 30, 2020 is inclusive of the loss on notes in the amount of $ 9,343,697 , loss on accrued interest in the amount of $ 1,046,085 and offset by the gain on the extinguishment of derivative liability in the amount of $ 4,919,957 (Note 8). 19 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) ​ 2018 BASF Venture Capital and Entrepreneurs Fund L.P. Notes On April 18, 2018, the Company entered into a convertible note agreement (the “2018 BASF Venture Capital and Entrepreneurs Fund L.P. Notes”), with BASF Venture Capital (“BASF”) and Entrepreneurs Fund L.P. (“EF”) with an aggregate principal of $ 5,861,848 . The 2018 BASF/EF Convertible Note was issued in three separate tranches on April 18, 2018, July 20, 2018 , and December 28, 2018 . The 2018 BASF Venture Capital and Entrepreneurs Fund L.P. Notes and accrued but unpaid interest were convertible into the common share based on (i) fund raising at a price paid per Senior Share equal to the price paid per Senior Share by the investors on a Fund Raising at a discount to the per share price in the Fund Raising, (ii) sale of the company at a price per Senior Share of $ 16.39 , or (iii) listing of the company on a publicly traded market at a price per Senior Share of $ 16.39 . The principal amount shall accrue interest at a rate of 8 % per annum, from the Issue Date up until the first anniversary of the Issue Date. Interest shall accrue on the principal amount at a rate of 15 % per annum from, and including, the first anniversary of the Issue Date up until the notes are (i) converted, cancelled, repaid or redeemed or (ii) the longstop date. Accrued interest was to be calculated on the basis of a 365 -day year for the actual number of days elapsed. 2018 Octopus Notes On July 20, 2018 the Company entered into a convertible note agreement (the “2018 Octopus Investment Limited Notes”) with Octopus Investment Limited (“Octopus”) with an aggregate nominal amount of $ 2,621,713 . The 2018 Octopus Convertible Note was issued in two separate tranches on July 20, 2018 and December 28, 2018 . The 2018 Octopus Notes and accrued but unpaid interest were convertible into the common shares based on (i) fund raising at a price paid per Senior Share equal to the price paid per Senior Share by the investors on a Fund Raising at a discount, (ii) sale of the company at a price per Senior Share of $ 15.10 , or (iii) listing of the company on a publicly traded market at a price per Senior Share of $ 15.10 . The principal amount shall accrue interest at a rate of 8 % per annum, from the Issue Date up until the first anniversary of the Issue Date. Interest shall accrue on the principal amount at a rate of 12 % per annum from, and including, the first anniversary of the Issue Date up until the notes are (i) converted, cancelled, repaid or redeemed or (ii) the longstop date. Accrued interest was to be calculated on the basis of a 365 -day year for the actual number of days elapsed. 2019 Octopus, EF, and Other Notes On June 26, 2019 the Company entered into a convertible note agreement (the “2019 Octopus, EF, and Other Notes”) with Octopus, EF, and various private investors with an aggregate nominal amount of $ 3,681,289 . The 2019 Octopus Convertible Note was issued in two separate tranches on June 26, 2019 and September 23, 2019 . The 2018 Octopus, EF, and Other Notes and accrued but unpaid interest were convertible into the common shares based on (i) fund raising at a price paid per Senior Share equal to the price paid per Senior Share by the investors on a Fund Raising at a discount, (ii) sale of the company at a price per Senior Share of $ 0.001861 , (iii) listing of the company on a publicly traded market at a price per Senior Share of $ 14.61 , or (ii) any date following the first anniversary of the date the of the Instrument at a price per Senior Share of $ 11.19 . The principal amount shall accrue interest at a rate of 10 % per annum, from the Issue Date up until the notes are (i) converted, cancelled, repaid or redeemed or (ii) the longstop date. Accrued interest was to be calculated on the basis of a 365 -day year for the actual number of days elapsed. The issuance of convertible notes with a beneficial redemption feature resulted in a debt discount of $ 2,608,351 . ​ ​ ​ ​ 20 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) ​ Notes Payable On January 26, 2021, the Company entered into a term loan facility agreement for the amount of $ 737,898 . 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 is to be utilized as collateral. The Lender is to be paid immediately following payment of research and development tax credit from the United Kingdom’s HM Revenue and Customs. The final repayment is due six months from the agreement date, if the loan and any interest has not been repaid in full prior to this date. The loan carries a monthly interest rate of 1.25 %. The interest accrues daily and compounds monthly on the monthly anniversary of the draw down date of the loan. ​ For six months ended June 30, 2021, the Company incurred an effective interest rate of 26.20 % relating to notes payable. There were no notes payable outstanding during for the six months ended June 30, 2020. The interest expense recognized based on the debt’s effective interest rate for six months ended June 30, 2021 and 2020, was $ 18,697 and zero , respectively, relating to notes payable. There were no notes payable outstanding during the three months ended June 30, 2021 and 2020, and no associated interest expense during the period. The Company repaid the note payable in full on March 2, 2021. There were no notes payable outstanding as of June 30, 2021 and December 31, 2020. ​ 8. DERIVATIVE ASSET: The company recorded a derivative asset related to the convertible notes outstanding during the six months ended June 30, 2020. The Company measured the derivative asset on a recurring basis using significant unobservable inputs (Level 3) for six months ended June 30, 2020. The Embedded Conversion Features are separately measured at fair value, with changes in fair value recognized in current operations. The original values of the Embedded Conversion Features were recorded as a derivative asset with the offset as a debt premium to the Convertible Notes which is being amortized over the term of the Convertible Notes. During the six months ended June 30, 2020, all outstanding convertible notes were converted into equity. The derivative asset was marked to market on the date of conversion and derecognized at conversion. The change in fair value of derivative asset included in earnings was $ 6,282,381 for the six months ended June 30, 2020. The gain on extinguishment of derivative asset upon conversion is $ 4,919,957 and is recorded as an offset within the loss on conversion of convertible notes payable on the consolidated statements of operations and comprehensive loss. ​ There were no convertible notes outstanding during the three and six months ended June 30, 2021, and no associated derivative asset during the period. ​ 9. 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. ​ 21 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) ​ 10. 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 ​ The Company’s common stock is not listed on a national securities exchange, an over-the-counter market or any other exchange. Therefore, there is no trading market, active or otherwise, for our common stock and the Company’s common stock may never be included for trading on any stock exchange, automated quotation system or any over-the-counter market. ​ 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 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 June 30, 2021, 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 $ 896,197 , 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 six months ended June 30, 2021. There were no warrants issued during the three months ended June 30, 2021. ​ 22 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) ​ A summary of the Company’s warrants to purchase common stock activity is as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Weighted- ​ ​ ​ ​ ​ ​ ​ Average ​ ​ ​ ​ Weighted- ​ Remaining ​ ​ ​ ​ Average ​ Contractual ​ ​ Number of ​ Exercise ​ Term ​ ​ Shares ​ Price ​ (Years) Warrants outstanding at January 1, 2021 — ​ $ — — Exercised — ​ — — Forfeited or Expired — ​ — — Granted 985,533 ​ 2.00 5.00 Warrants outstanding at June 30, 2021 985,533 ​ $ 2.00 4.65 ​ 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 $ 4,314,320 during the six months ended June 30, 2021. During the three and six months ended June 30, 2021, no warrants issued to investors were exercised. The grant date fair value for these warrants of $ 1.99 is based on the stock price at issuance date of $ 2.00 less the exercise price of $ 0.01 . The pre-funded common stock warrants have no expiration date and terminate upon exercise. ​ A summary of the Company’s pre-funded warrants to purchase common stock activity is as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Weighted- ​ ​ ​ ​ Average ​ ​ Number of ​ Exercise ​ ​ Shares ​ Price Pre-funded warrants outstanding at January 1, 2021 — ​ $ — Exercised — ​ — Forfeited or Expired — ​ — Granted 2,168,000 ​ 0.01 Pre-funded warrants outstanding at June 30, 2021 2,168,000 ​ $ 0.01 ​ The grant date fair value of common stock warrants is determined using the Black Scholes option-pricing model. The Company is a private company and estimates its expected stock volatility based on historical volatility of publicly traded peer companies. The following assumptions were used during the six months ended June 30, 2021: ​ ​ ​ ​ ​ Six Months Ended ​ June 30, 2021 Expected term (years) 5 years Risk-free interest rate 0.60 % Expected volatility 54 % Expected dividend yield 0 % ​ There were no common stock warrants issued during the six months ended June 30, 2020. ​ 23 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) ​ 11. 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 and to encourage them to devote their best efforts to the business of SmartKem Limited, thereby advancing the interests of SmartKem Limited and its shareholders. Options were issued to certain employees and service providers under the investment agreement dated July 15, 2014, which provided for the grant of up to 175,292 options. On December 14, 2018, the Company entered into a written resolution, which allowed SmartKem Limited to grant up to 458,316 options. SmartKem Limited adopted a new Investment Agreement (the “Agreement”) dated January 24, 2020, SmartKem Limited, by means of the Agreement, seeks to retain the services of such eligible persons and to provide incentives for such persons to exert maximum efforts for the success of SmartKem Limited. The Agreement commenced on the January 24, 2020 and the Agreement is administered by Board of Directors. The maximum aggregate number of shares of common shares which may be issued under all Awards granted to Participants under the Agreement shall be 15 % of SmartKem Limited’s issued capital shares. In the event of a termination of continuous service (other than as a result of a change of control, as defined in the Agreement), unvested share options generally shall terminate and, with regard to vested share options, the exercise period shall be the lesser of the original expiration date or six months from the date continuous service terminates. The Company has granted these share option awards to employees and consultants. Outstanding options generally expire 10 years after the grant date. Options are subject to vesting and, grantees become fully vested and exercisable when there is a liquidity event, such as a change in control or sale or admission (listing as a public company or initial public offering (“IPO”)), and the employee, or consultant, must be providing services to the Company at the time of the event. As of the date of the reverse merger and recapitalization all outstanding options which had not been exercised were cancelled and the Company issued options under the 2021 Equity Incentive Plan (“2021 Plan”) in consideration for the cancelled options. On February 23, 2021 the Company approved the 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. There were no options granted or modified for the three months ended March 31, 2020. As a result of the reverse merger an aggregate of 402,586 options were issued during February 2021 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. In addition, the Company issued a further 1,193,976 options during March and April 2021 for employees and directors. The options vest over a period of four years , have an exercise price of $ 2.00 per share and expire on the ten year anniversary of the grant date. ​ 24 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) ​ Determining the appropriate fair value of share-based awards requires the input of subjective assumptions, including the fair value of the Company’s common shares, and for share options, the expected life of the option, and expected share price volatility. The Company uses the Black-Scholes option pricing model to value its share option awards. The assumptions used in calculating the fair value of share-based awards represent management’s best estimates and involves inherent uncertainties and the application of management’s judgment. As a result, if factors change and management uses different assumptions, the share-based compensation expense could be materially different for future awards. Options granted under the 2021 Plan for six months ended June 30, 2021 were valued using the Black-Scholes option-pricing model with the following assumptions: ​ ​ ​ ​ Six Months Ended ​ June 30, 2021 Expected term (years) 5 years - 6 years Risk-free interest rate 0.5 % - 1.2 % Expected volatility 54 % - 56 % Expected dividend yield 0 % ​ 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). Once the Company’s common shares are publicly traded, the Company will no longer have to estimate the fair value of the common share, rather the value will be determined based on quoted market prices. The Company determined the fair value of common share using methodologies, approaches and assumptions consistent with the AICPA Practice Guide, Valuation of Privately Held Company Equity Securities Issued as Compensation and based in part on input from an independent third-party valuation firm. The Company estimates its expected volatility by using a combination of historical share price volatilities of similar companies within our industry. The risk-free interest rate assumption is based on observed interest rates for the appropriate term of the Company’s options on a grant date. The expected option term assumption is the contractual term, as the service period is implied under the practical expedient, since the Company does not have sufficient exercise history to estimate expected term of its historical option awards. The following table reflects share activity under the share option plans for six months ended June 30, 2021: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Weighted- ​ ​ ​ ​ ​ ​ ​ ​ ​ Average ​ ​ ​ ​ ​ ​ ​ Weighted- ​ Remaining ​ Weighted- ​ ​ ​ ​ Average ​ Contractual ​ Average ​ ​ Number of ​ Exercise ​ Term ​ Fair Value at ​ ​ Shares ​ Price ​ (Years) ​ Grant Date Options outstanding at January 1, 2021 1,810,749 ​ $ 0.06143 9.70 ​ $ 3.46867 Exercised ( 1,404,813 ) ​ 0.01466 ​ Cancelled ( 405,936 ) ​ 0.06452 ​ Granted 1,596,562 ​ 1.57861 ​ Options outstanding at June 30, 2021 1,596,562 ​ $ 1.57861 9.73 ​ $ 1.22084 ​ The weighted-average grant-date fair value per share option granted for the six months ended June 30, 2021 was $ 1.22 . ​ As of June 30, 2021, there were 402,586 exercisable options outstanding. ​ 25 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) ​ Stock-based compensation, including stock options and warrants is included in the unaudited condensed consolidated statements of operations as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ For the Three Months Ended June 30, ​ For the Six Months Ended June 30, ​ ​ 2021 2020 2021 2020 Research and development ​ $ 23,816 ​ $ — ​ $ 2,931,308 ​ $ — Selling, general and administrative ​ 51,385 ​ — ​ 3,163,410 ​ — Total ​ $ 75,201 ​ $ — ​ $ 6,094,718 ​ $ — ​ Total compensation cost related to non-vested stock option awards not yet recognized as of June 30, 2021 was $ 1,147,842 and will be recognized on a straight-line basis through the end of the vesting periods April 2025. The amount of future stock option compensation expense could be affected by any future option grants or by any forfeitures. 12. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES: Selling, general and administrative expenses are comprised of the following items: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ For the Three Months Ended June 30, For the Six Months Ended June 30, ​ 2021 2020 2021 2020 Salaries and benefits ​ $ 489,122 ​ $ 182,871 ​ $ 4,216,562 ​ $ 473,041 Rent expense ​ 2,763 ​ 3,467 ​ 16,008 ​ 20,775 Insurance ​ ​ 154,875 ​ ​ — ​ ​ 154,875 ​ ​ — Utilities ​ 943 ​ ( 1,683 ) ​ 1,593 ​ ( 1,316 ) Sales and marketing ​ 83,168 ​ 10,454 ​ 105,098 ​ 33,767 Legal and professional fees ​ 558,543 ​ 47,147 ​ 708,111 ​ 230,244 Other selling, general, and administrative expenses ​ 55,834 ​ 520 ​ 125,826 ​ 12,376 Total ​ $ 1,345,248 ​ $ 242,776 ​ $ 5,328,073 ​ $ 768,887 ​ ​ 13. 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. Contributions for the three months ended June 30, 2021 and 2020 were $ 33,263 and $ 15,377 , respectively, and $ 64,737 and $ 41,264 for the six months ended June 30, 2021 and 2020. Pension cost is included in the unaudited condensed consolidated statements of operations as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ For the Three Months Ended June 30, ​ For the Six Months Ended June 30, ​ 2021 2020 2021 2020 Research and development ​ $ 24,353 ​ $ 19,424 ​ $ 47,779 ​ $ 41,246 Selling, general and administrative ​ 8,910 ​ ( 4,047 ) ​ 16,958 ​ 18 Total pension cost ​ $ 33,263 ​ $ 15,377 ​ $ 64,737 ​ $ 41,264 ​ As of June 30, 2021 and December 31, 2020 there were no amounts owed to the pension scheme. ​ 26 Table of Contents SMARTKEM, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) ​ 14. RELATED PARTY TRANSACTIONS: In addition to transactions and balances related share-based compensation to officers and directors, the Company incurred expenses of $ 18,000 and $ 2,099 , for the three months ended June 30, 2021 and 2020, respectively, and $ 24,904 and $ 2,099 , for the six months ended June 30, 2021 and 2020, 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 condensed consolidated statements of operations. As of June 30, 2021 and December 31, 2020, there was $ 9,000 and zero , respectively, payable to members of the Board of Directors that are recorded in accounts payable and accrued expenses on the condensed consolidated balance sheets. ​ During the three and six months ended June 30, 2021, the Company reimbursed an owner for legal fees and other expenses as a result of the Exchange (see Note 1). The reimbursement of these fees for services resulted in an expense of $ 65,690 for the three and six months ended June 30, 2021. There was $ 42,222 payable as of June 30, 2021, which is recorded in accounts payable and accrued expenses on the condensed consolidated balance sheets. ​ The Company obtained consulting services from an individual who is a family member of a Director of the Company. The consulting services resulted in an expense of $ 21,004 and $ 34,834 for the three and six months ended June 30, 2021. There was $ 6,910 payable as of June 30, 2021, which is recorded in accounts payable and accrued expenses on the condensed consolidated balance sheets. ​ 15. SUBSEQUENT EVENTS: During August 2021, the Company issued a further 411,150 EMI Options to employees and directors under the 2021 Plan. The options vest over a period of four years , expire on the tenth anniversary of the grant date and have an exercise price of $ 2.00 per share. ​ In July 2021, the board approved the issue of 60,000 shares of the Company’s common stock to a vendor in consideration for services to be provided. ​ ​ 27 Table of Contents