SmartKem, Inc. 10-Q

Item 1. Financial Statements ​ SMARTKEM, INC. Condensed Consolidated Balance Sheets (Unaudited) (in thousands, except number of shares and per share data) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ June 30, ​ December 31, ​ 2023 ​ 2022 Assets ​ ​ ​ Current assets ​ ​ ​ ​ ​ ​ Cash and cash equivalents ​ $ 13,774 ​ $ 4,235 Accounts receivable ​ 1 ​ 30 Research and development tax credit receivable ​ 355 ​ 1,121 Prepaid expenses and other current assets ​ 941 ​ 1,056 Total current assets ​ 15,071 ​ 6,442 Property, plant and equipment, net ​ 558 ​ 602 Right-of-use assets, net ​ 415 ​ 475 Other assets, non-current ​ 6 ​ 6 Total assets ​ $ 16,050 ​ $ 7,525 ​ ​ ​ ​ ​ ​ ​ Liabilities and stockholders’ equity ​ ​ Current liabilities ​ ​ ​ ​ ​ ​ Accounts payable and accrued expenses ​ $ 1,494 ​ $ 931 Lease liabilities, current ​ 245 ​ 206 Income tax payable ​ ​ — ​ ​ 22 Other current liabilities ​ ​ 13 ​ ​ 244 Total current liabilities ​ 1,752 ​ 1,403 Lease liabilities, non-current ​ 135 ​ 239 Warrant liability ​ ​ 1,834 ​ — Total liabilities ​ 3,721 ​ 1,642 ​ ​ ​ ​ ​ ​ ​ Commitments and contingencies (Note 6) ​ — ​ — ​ ​ ​ ​ ​ ​ ​ Stockholders’ equity: ​ ​ Preferred stock, par value $ 0.0001 per share, 10,000,000 shares authorized, 14,149 and zero shares issued and outstanding , at June 30, 2023 and December 31, 2022, respectively ​ — ​ — Common stock, par value $ 0.0001 per share, 300,000,000 shares authorized, 27,087,773 and 26,984,996 shares issued and outstanding , at June 30, 2023 and December 31, 2022, respectively ​ 3 ​ 3 Additional paid-in capital ​ 104,424 ​ 92,930 Accumulated other comprehensive loss ​ ( 1,456 ) ​ ( 483 ) Accumulated deficit ​ ( 90,642 ) ​ ( 86,567 ) Total stockholders' equity ​ 12,329 ​ 5,883 Total liabilities and stockholders’ equity ​ $ 16,050 ​ $ 7,525 ​ ​ ​ ​ ​ ​ ​ ​ The accompanying notes are an integral part of these unaudited interim condensed consolidated financial statements. ​ 3 Table of Contents SMARTKEM, INC. Condensed Consolidated Statements of Operations and Comprehensive Loss (Unaudited) (in thousands, except number of shares and per share data) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Three Months Ended June 30, ​ Six Months Ended June 30, ​ ​ 2023 2022 2023 2022 Revenue ​ $ 8 ​ $ 4 ​ $ 24 ​ $ 34 ​ Cost of revenue ​ 6 ​ 2 ​ 22 ​ 25 ​ Gross profit ​ 2 ​ 2 ​ 2 ​ 9 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Other operating income ​ 169 ​ ​ 294 ​ 438 ​ 578 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Operating expenses ​ ​ ​ ​ ​ Research and development ​ 1,257 ​ ​ 1,344 ​ 2,536 ​ 2,802 ​ Selling, general and administrative ​ 1,324 ​ ​ 1,370 ​ 2,757 ​ 2,611 ​ Loss/(gain) on foreign currency transactions ​ ( 43 ) ​ ​ — ​ 68 ​ — ​ Total operating expenses ​ 2,538 ​ 2,714 ​ 5,361 ​ 5,413 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Loss from operations ​ ( 2,367 ) ​ ( 2,418 ) ​ ( 4,921 ) ​ ( 4,826 ) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Non-operating income/(expense) ​ ​ ​ ​ ​ Gain/(loss) on foreign currency transactions ​ ​ 533 ​ ​ ( 1,284 ) ​ ​ 1,035 ​ ​ ( 1,638 ) ​ Transaction costs allocable to warrants ​ ​ ( 198 ) ​ ​ — ​ ​ ( 198 ) ​ ​ — ​ Change in fair value of the warrant liability ​ ​ 3 ​ ​ — ​ ​ 3 ​ ​ — ​ Interest income ​ 2 ​ ​ 1 ​ 6 ​ 1 ​ Total non-operating income/(expense) ​ 340 ​ ( 1,283 ) ​ 846 ​ ( 1,637 ) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Loss before income taxes ​ ( 2,027 ) ​ ( 3,701 ) ​ ( 4,075 ) ​ ( 6,463 ) ​ Income tax expense ​ — ​ ​ — ​ — ​ ​ — ​ Net loss ​ $ ( 2,027 ) ​ $ ( 3,701 ) ​ $ ( 4,075 ) ​ $ ( 6,463 ) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Net loss ​ $ ( 2,027 ) ​ $ ( 3,701 ) ​ $ ( 4,075 ) ​ $ ( 6,463 ) ​ Other comprehensive loss: ​ ​ ​ ​ ​ Foreign currency translation ​ ( 517 ) ​ ​ 722 ​ ( 973 ) ​ 878 ​ Total comprehensive loss ​ $ ( 2,544 ) ​ $ ( 2,979 ) ​ $ ( 5,048 ) ​ $ ( 5,585 ) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Basic and diluted net loss per common share ​ $ ( 0.05 ) ​ $ ( 0.13 ) ​ $ ( 0.12 ) ​ $ ( 0.23 ) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Basic and diluted weighted average shares outstanding ​ ​ 38,916,386 ​ ​ 28,751,365 ​ ​ 34,108,976 ​ ​ 28,595,550 ​ ​ ​ The accompanying notes are an integral part of these unaudited interim condensed consolidated financial statements. ​ ​ ​ 4 Table of Contents SMARTKEM, INC. Condensed Consolidated Statements of Stockholders’ Equity (Unaudited) (in thousands, except share data) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Accumulated ​ ​ ​ ​ ​ ​ ​ ​ Preferred Stock ​ Common stock ​ Additional ​ other ​ ​ ​ ​ Total ​ ​ $0.0001 par value ​ $0.0001 par value ​ paid-in ​ comprehensive ​ Accumulated ​ Stockholders' ​ ​ Shares Amount ​ Shares Amount capital income deficit equity Balance at January 1, 2023 ​ — ​ $ — ​ 26,984,996 ​ $ 3 ​ $ 92,930 ​ $ ( 483 ) ​ $ ( 86,567 ) ​ $ 5,883 Stock-based compensation expense ​ — ​ — ​ — ​ — ​ 293 ​ — ​ — ​ 293 Issuance of common stock to vendor ​ — ​ — ​ 102,777 ​ — ​ 55 ​ — ​ — ​ 55 Foreign currency translation adjustment ​ — ​ — ​ — ​ — ​ — ​ ( 456 ) ​ — ​ ( 456 ) Net loss ​ — ​ — ​ — ​ — ​ — ​ — ​ ( 2,048 ) ​ ( 2,048 ) Balance at March 31, 2023 ​ — ​ ​ — ​ 27,087,773 ​ ​ 3 ​ ​ 93,278 ​ ​ ( 939 ) ​ ​ ( 88,615 ) ​ ​ 3,727 Stock-based compensation expense ​ — ​ — ​ — ​ — ​ 119 ​ — ​ — ​ 119 Issuance of preferred stock, net of issuance costs ​ 14,149 ​ — ​ — ​ — ​ 11,027 ​ — ​ — ​ 11,027 Foreign currency translation adjustment ​ — ​ — ​ — ​ — ​ — ​ ( 517 ) ​ — ​ ( 517 ) Net loss ​ — ​ — ​ — ​ — ​ — ​ — ​ ( 2,027 ) ​ ( 2,027 ) Balance at June 30, 2023 ​ 14,149 ​ $ — ​ 27,087,773 ​ $ 3 ​ $ 104,424 ​ $ ( 1,456 ) ​ $ ( 90,642 ) ​ $ 12,329 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Preferred Stock ​ Common stock ​ Additional ​ other ​ ​ ​ ​ Total ​ ​ $0.0001 par value ​ $0.0001 par value ​ paid-in ​ comprehensive ​ Accumulated ​ Stockholders' ​ ​ Shares Amount ​ Shares Amount capital income deficit equity Balance at January 1, 2022 ​ — ​ $ — ​ 25,554,309 ​ $ 3 ​ $ 89,954 ​ $ ( 1,363 ) ​ $ ( 75,072 ) ​ $ 13,522 Stock-based compensation expense ​ — ​ — ​ — ​ — ​ 98 ​ — ​ — ​ 98 Issuance of common stock to vendor ​ — ​ — ​ 12,500 ​ — ​ 43 ​ — ​ — ​ 43 Issuance of common stock in private placement ​ — ​ ​ — ​ 1,000,000 ​ ​ — ​ ​ 2,000 ​ ​ — ​ ​ — ​ ​ 2,000 Issuance costs related to common stock in private placement ​ — ​ ​ — ​ — ​ ​ — ​ ​ ( 160 ) ​ ​ — ​ ​ — ​ ​ ( 160 ) Foreign currency translation adjustment ​ — ​ — ​ — ​ — ​ — ​ 156 ​ — ​ 156 Net loss ​ — ​ — ​ — ​ — ​ — ​ — ​ ( 2,762 ) ​ ( 2,762 ) Balance at March 31, 2022 ​ — ​ ​ — ​ 26,566,809 ​ ​ 3 ​ ​ 91,935 ​ ​ ( 1,207 ) ​ ​ ( 77,834 ) ​ ​ 12,897 Stock-based compensation expense ​ — ​ — ​ — ​ — ​ 97 ​ — ​ — ​ 97 Issuance of common stock to vendor ​ — ​ — ​ 382,473 ​ — ​ 590 ​ — ​ — ​ 590 Issuance costs related to preferred stock in private placement ​ — ​ — ​ — ​ — ​ ( 10 ) ​ — ​ — ​ ( 10 ) Foreign currency translation adjustment ​ — ​ — ​ — ​ — ​ — ​ 722 ​ — ​ 722 Net loss ​ — ​ — ​ — ​ — ​ — ​ — ​ ( 3,701 ) ​ ( 3,701 ) Balance at June 30, 2022 ​ — ​ $ — ​ 26,949,282 ​ $ 3 ​ $ 92,612 ​ $ ( 485 ) ​ $ ( 81,535 ) ​ $ 10,595 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ The accompanying notes are an integral part of these unaudited interim condensed consolidated financial statements . ] ​ 5 Table of Contents SMARTKEM, INC. Condensed Consolidated Statements of Cash Flows (Unaudited) (in thousands) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Six Months Ended June 30, ​ 2023 2022 Cash flow from operating activities: ​ ​ Net loss ​ $ ( 4,075 ) ​ $ ( 6,463 ) Adjustments to reconcile net loss to net cash used in operating activities: ​ ​ Depreciation ​ ​ 81 ​ ​ 105 Stock-based compensation expense ​ ​ 412 ​ ​ 195 Issuance of common stock to vendor ​ ​ 55 ​ ​ 633 Right-of-use asset amortization ​ ​ 134 ​ ​ 131 Gain/(loss) on foreign currency transactions ​ ​ ( 962 ) ​ ​ 1,638 Transaction costs allocable to warrant liability ​ ​ 198 ​ ​ — Change in fair value of the warrant liability ​ ​ ( 3 ) ​ ​ — Change in operating assets and liabilities: ​ ​ ​ ​ ​ ​ Accounts receivable ​ ​ 30 ​ ​ ( 6 ) Research and development tax credit receivable ​ ​ 804 ​ ​ ( 578 ) Prepaid expenses and other current assets ​ ​ ( 64 ) ​ ​ ( 1,057 ) Accounts payable and accrued expenses ​ ​ 718 ​ ​ ( 134 ) Lease liabilities ​ ​ ( 137 ) ​ ​ ( 115 ) Income tax payable ​ ​ ( 23 ) ​ ​ — Other current liabilities ​ ​ ( 238 ) ​ ​ — Net cash used in operating activities ​ ( 3,070 ) ​ ( 5,651 ) ​ ​ ​ ​ ​ ​ ​ Cash flows from investing activities: ​ ​ Purchases of property, plant and equipment ​ ​ ( 6 ) ​ ​ ( 58 ) Net cash used by investing activities ​ ( 6 ) ​ ( 58 ) ​ ​ ​ ​ ​ ​ ​ Cash flow from financing activities: ​ ​ Proceeds from the issuance of preferred stock in private placement ​ ​ 12,386 ​ ​ 2,000 Proceeds from the issuance of warrants in private placement ​ ​ 1,763 ​ ​ — Payment of issuance costs ​ ​ ( 1,483 ) ​ ​ ( 170 ) Net cash provided by financing activities ​ 12,666 ​ 1,830 ​ ​ ​ ​ ​ ​ ​ Effect of exchange rate changes on cash ​ ​ ( 51 ) ​ ( 590 ) ​ ​ ​ ​ ​ ​ ​ Net change in cash ​ 9,539 ​ ( 4,469 ) ​ ​ ​ ​ ​ ​ ​ Cash, beginning of period ​ ​ 4,235 ​ ​ 12,226 Cash, end of period ​ $ 13,774 ​ $ 7,757 ​ ​ ​ ​ ​ ​ ​ Supplemental disclosure of cash and non-cash investing and financing activities ​ ​ Initial classification of fair value of warrants ​ $ 1,837 ​ $ — Right-of-use asset and lease liability additions ​ $ 50 ​ $ 539 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ The accompanying notes are an integral part of these unaudited interim condensed consolidated financial statements. ​ ​ ​ 6 Table of Contents SMARTKEM, INC. Notes to Condensed Consolidated Financial Statements ​ 1. ORGANIZATION, BUSINESS, LIQUIDITY AND BASIS OF PRESENTATION Organization SmartKem, formerly known as Parasol Investments Corporation (“Parasol”), was formed on May 13, 2020, and is the successor of SmartKem Limited, which was formed under the Laws of England and Wales. The Company was founded as a “shell” company registered under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), with no specific business plan or purpose until it began operating the business of SmartKem Limited following the closing of the transactions contemplated by the Securities Exchange Agreement (“the Exchange Agreement”), dated February 21, 2021, 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 and which were purchased by Parasol for an aggregate purchase price of $ 1.40 , were exchanged for shares of Parasol common stock and SmartKem Limited became a wholly owned subsidiary of Parasol (the “Exchange”). Business The Company is seeking to reshape the world of electronics with its disruptive organic thin-film transistors (OTFTs) that have the potential to drive the next generation of displays. SmartKem’s patented TRUFLEX® semiconductor and dielectric inks, or liquid electronic polymers, are used to make a new type of transistor that could potentially revolutionize the display industry. SmartKem’s inks enable low temperature printing processes that are compatible with existing manufacturing infrastructure to deliver low-cost displays that outperform existing models. The company’s electronic polymer platform can be used in a number 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. SmartKem develops its materials at its research and development facility in Manchester, UK, its semiconductor manufacturing processes at the Centre for Process Innovation (CPI) at Sedgefield, UK and retains a field application office in Taiwan. The Company has an extensive IP portfolio including 125 granted patents across 19 patent families and 40 codified trade secrets. 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. Liquidity The accompanying unaudited interim condensed consolidated financial statements have been presented on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the ordinary course of business. We have incurred continuing losses including net losses of $ 4.1 million for the six months ended June 30, 2023. The Company’s cash as of June 30, 2023 was $ 13.8 million. We anticipate operating losses to continue for the foreseeable future due to, among other things, costs related to research funding, further development of our technology and products and expenses related to the commercialization of our products. 7 Table of Contents SMARTKEM, INC. Notes to Condensed Consolidated Financial Statements ​ In June 2023 the Company raised $ 14.0 million through two closings of a private placement of Preferred Stock and Warrants. Net proceeds after related expenses were $ 12.7 million, alleviating substantial doubt about the Company's ability to continue as a going concern. As a result, the Company’s cash balance at June 30, 2023 was $ 13.8 million. The Company used approximately $ 3.1 million of cash in its operating activities for the six months ended June 30, 2023. Management believes that the Company’s existing cash as of June 30, 2023 will be sufficient to fund the operations of the Company for the twelve months from the issuance of this financial statement, and that the Company may require additional capital funding to continue its operations and research and development activity thereafter. Basis of Presentation The unaudited interim condensed consolidated financial statements of SmartKem, Inc. (“SmartKem” or the “Company”) as of June 30, 2023 and December 31, 2022 and for the three and six months ended June 30, 2023 and 2022 should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2022 (the “Annual Report”), which was filed with the Securities and Exchange Commission (the “SEC”) on March 30, 2023 and may also be found on the Company’s website (www.smartkem.com). In these notes to the interim condensed consolidated financial statements the terms “us,” “we” or “our” refer to SmartKem and its consolidated subsidiaries. These interim condensed consolidated financial statements are unaudited and were prepared by the Company in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim reporting and with the SEC’s instructions to Form 10-Q and Article 10 of Regulation S-X. They include the accounts of all wholly owned subsidiaries and all significant inter-company accounts and transactions have been eliminated in consolidation. Amounts are presented in thousands, except number of shares and per share data. The preparation of interim condensed consolidated financial statements requires management to make assumptions and estimates that impact the amounts reported. These interim condensed consolidated financial statements reflect all adjustments, consisting of normal recurring accruals, necessary for a fair presentation of the Company’s results of operations, financial position and cash flows for the interim periods ended June 30, 2023 and 2022; however, certain information and footnote disclosures normally included in our audited consolidated financial statements included in our Annual Report have been condensed or omitted as permitted by GAAP. It is important to note that the Company’s results of operations and cash flows for interim periods are not necessarily indicative of the results of operations and cash flows to be expected for a full fiscal year or any interim period. 2. SUMMARY OF SIGNIIFICANT ACCOUNTING POLICIES Other than the policies listed below, there have been no material changes to our significant accounting policies as set forth in Note 3 Summary of Significant Accounting Policies to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2022. ​ Management’s Use of Estimates ​ The preparation of consolidated financial statements in conformity with accounting standards generally accepted in the United States of America ("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 fair value of warrant liabilities. 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 8 Table of Contents SMARTKEM, INC. Notes to Condensed Consolidated Financial Statements ​ 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. ​ Warrant Liability ​ The Company assessed its warrants in accordance with the guidance contained in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) ASC 480, Distinguishing Liabilities from Equity and 815-40, Derivatives and Hedging—Contracts in Entity’s Own Equity , 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. ​ 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. The total issuance costs were $ 1.6 million, with $ 0.2 million charged directly to the statement of operations. 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 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 August 2020, the FASB issued ASU No. 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity , which simplifies accounting for convertible instruments by removing major separation models required under current GAAP. The ASU removes certain settlement conditions that are required for equity contracts to qualify for the derivative scope exception, and it also simplifies the diluted earnings per share calculation in certain areas. This ASU is effective for annual reporting periods beginning after December 15, 2021, including interim periods within those fiscal years. The Company adopted the ASU on January 1, 2023. This update permits the use of either the modified retrospective or fully retrospective method of transition. The Company has determined that the impact this ASU did not have material effect on its consolidated financial statements. 9 Table of Contents SMARTKEM, INC. Notes to Condensed Consolidated Financial Statements ​ 3. PREPAID EXPENSES AND OTHER CURRENT ASSETS Prepaid expenses and other current assets consist of the following: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ June 30, ​ December 31, (in thousands) 2023 ​ 2022 Prepaid service charges and property taxes ​ $ 99 ​ $ 55 Prepaid utilities ​ 78 ​ 51 Prepaid insurance ​ 461 ​ 358 Prepaid administrative expenses ​ 77 ​ 35 Prepaid consulting fees ​ ​ 32 ​ ​ 304 Research grant receivable ​ ​ 35 ​ ​ — Prepaid technical fees ​ ​ 15 ​ ​ 22 VAT receivable ​ ​ 104 ​ ​ 195 Other receivable and other prepaid expenses ​ ​ 40 ​ ​ 36 Total prepaid expenses and other current assets ​ $ 941 ​ $ 1,056 ​ ​ ​ ​ ​ ​ ​ ​ 4. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consist of the following: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ June 30, ​ December 31, (in thousands) 2023 ​ 2022 Plant and equipment ​ $ 1,568 ​ $ 1,478 Furniture and fixtures ​ 231 ​ 218 Computer hardware and software ​ 24 ​ 24 ​ ​ 1,823 ​ 1,720 Less: Accumulated depreciation ​ ( 1,265 ) ​ ( 1,118 ) Property, plant and equipment, net ​ $ 558 ​ $ 602 ​ ​ ​ ​ ​ ​ ​ ​ Depreciation expense was $ 0.1 million and $ 0.1 million for the three months ended June 30, 2023 and 2022, respectively, and $ 0.1 million is classified as research and development expense. 5. ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses consist of the following: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ June 30, ​ December 31, (in thousands) 2023 ​ 2022 Accounts payable ​ $ 680 ​ $ 230 Accrued expenses – lab refurbishments ​ 123 ​ 117 Accrued expenses – technical fees ​ 76 ​ 130 Accrued expenses – variable rent & utilities ​ ​ 2 ​ ​ 15 Accrued expenses – audit & accounting fees ​ 143 ​ 128 Accrued expenses – legal & other professional services ​ ​ 126 ​ ​ — Accrued expenses – other ​ 5 ​ 80 Credit card liabilities ​ ​ 17 ​ ​ 20 Payroll liabilities ​ 322 ​ 211 Total accounts payable and accrued expenses ​ $ 1,494 ​ $ 931 ​ ​ ​ ​ ​ ​ ​ ​ 10 Table of Contents SMARTKEM, INC. Notes to Condensed Consolidated Financial Statements ​ 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. 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 leases for the periods ended: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Three Months Ended June 30, ​ Six Months Ended June 30, ​ (in thousands) 2023 2022 2023 2022 Operating lease cost ​ $ 75 ​ $ 68 ​ $ 139 ​ $ 131 ​ Short-term lease cost ​ 3 ​ 2 ​ 7 ​ 4 ​ Variable lease cost ​ 20 ​ 41 ​ 65 ​ 95 ​ Total lease cost ​ $ 98 ​ $ 111 ​ $ 211 ​ $ 230 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ The total lease cost is included in the unaudited condensed consolidated statements of operations as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Three Months Ended June 30, ​ Six Months Ended June 30, ​ (in thousands) ​ 2023 2022 2023 2022 Research and development ​ $ 95 ​ $ 105 ​ $ 199 ​ $ 218 ​ Selling, general and administrative ​ 3 ​ 6 ​ 12 ​ 12 ​ Total lease cost ​ $ 98 ​ $ 111 ​ $ 211 ​ $ 230 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Right of use lease assets and lease liabilities for our operating leases were recorded in the unaudited condensed consolidated balance sheet as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ June 30, ​ December 31, (in thousands) 2023 2022 Assets ​ ​ ​ Right-of-use assets, net ​ $ 415 ​ $ 475 Total lease assets ​ $ 415 ​ $ 475 ​ ​ ​ ​ ​ ​ ​ Liabilities ​ ​ Current liabilities: ​ ​ Lease liability, current ​ $ 245 ​ $ 206 Noncurrent liabilities: ​ ​ ​ Lease liability, non-current ​ 135 ​ 239 Total lease liabilities ​ $ 380 ​ $ 445 ​ ​ ​ ​ ​ ​ ​ ​ The Company had no right of use lease assets and lease liabilities for financing leases as of June 30, 2023 and December 31, 2022. 11 Table of Contents SMARTKEM, INC. Notes to Condensed Consolidated Financial Statements ​ The table below presents certain information related to the cash flows for the Company’s operating leases for the periods ended: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ June 30, ​ (in thousands) ​ 2023 2022 Operating cash outflows from operating leases ​ $ 137 ​ $ 115 ​ Supplemental non-cash amounts of operating lease liabilities arising from obtaining right of use assets ​ 50 ​ 539 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ The table below presents certain information related to the weighted average remaining lease term and the weighted average discount rate for the Company’s operating leases as of the period ended: ​ ​ ​ ​ ​ ​ ​ June 30, ​ ​ 2023 Weighted average remaining lease term (in years)  – operating leases ​ ​ 1.80 Weighted average discount rate – operating leases ​ ​ 8.03 % ​ Remaining maturities of the Company’s operating leases, excluding short-term leases, are as follows: ​ ​ ​ ​ ​ ​ ​ June 30, (in thousands) ​ 2023 2023 ​ $ 151 2024 ​ ​ 237 2025 ​ ​ 19 Total undiscounted lease payments ​ ​ 407 Less imputed interest ​ ​ ( 27 ) Total net lease liabilities ​ $ 380 ​ ​ ​ ​ ​ 7. 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 interim condensed consolidated financial statements. 8. STOCKHOLDERS’ EQUITY 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. Series A-1 Preferred Stock On June 14, 2023, the Company filed a Certificate of Designation of Preferences, Rights and Limitations with the Secretary of State of the State of Delaware designating 18,000 shares out of the authorized but unissued shares of its preferred stock as Series A-1 Preferred Stock with a stated value of $ 1,000 per share (the “Series A-1 Certificate of Designation”). The following is a summary of the principal terms of the Series A-1 Preferred Stock as set forth in the Series A-1 Certificate of Designation: ​ 12 Table of Contents SMARTKEM, INC. Notes to Condensed Consolidated Financial Statements ​ Dividends ​ The holders of Series A-1 Preferred Stock will be entitled to dividends, on an as-if converted basis, equal to and in the same form as dividends actually paid on shares of Common Stock, when and if actually paid. In addition, in the event that on the 18 th month anniversary of the Closing Date, the trailing 30-day VWAP (as defined in the Series A-1 Certificate of Designation) is less than the then-effective Series A-1 Conversion Price, the Series A-1 Preferred Stock will begin accruing dividends at the annual rate of 19.99 % of the stated value thereof (the “Series A-1 Dividend”). The Series A-1 Dividend would be paid in cash, or, at the option of the Company if certain equity conditions are met, in shares of Common Stock at a price per share equal to ninety percent (90%) of the trailing 10-day VWAP for the last 10 trading date prior to the date the Series A-1 Dividend is paid. Voting Rights The shares of Series A-1 Preferred Stock have no voting rights, except (a) the right to vote, with the holders of Common Stock, as a single class, on any resolution presented to stockholders for the purpose of obtaining approval of a proposed amendment to the Charter to effect a reverse split of the outstanding shares of the Common Stock at a ratio to be determined, with each share of Series A-1 Preferred Stock entitled to vote on an as-converted basis and (b) to the extent required by the Delaware General Corporation Law (the “DGCL”). As long as any shares of Series A-1 Preferred Stock are outstanding, the Company may not, without the approval of a majority of the then outstanding shares of Series A-1 Preferred Stock which must include AIGH Investment Partners LP and its affiliates (“AIGH”) for so long as AIGH is holding at least $ 1,500,000 in aggregate stated value of Series A-1 Preferred Stock acquired pursuant to the Purchase Agreement (a) alter or change the powers, preferences or rights given to the Series A-1 Preferred Stock, (b) alter or amend the Charter, the Series A-1 Certificate of Designation, the Series A-2 Certificate of Designation (as defined below) or the bylaws of the Company (the “Bylaws”) in such a manner so as to materially adversely affect any rights given to the Series A-1 Preferred Stock, (c) authorize or create any class of stock ranking as to dividends, redemption or distribution of assets upon a Liquidation (as defined below) senior to, or otherwise pari passu with, the Series A-1 Preferred Stock, other than the Series A-2 Preferred Stock, (d) increase the number of authorized shares of Series A-1 Preferred Stock, (e) issue any Series A-1 Preferred Stock except pursuant to the Purchase Agreement, or (f) enter into any agreement to do any of the foregoing. Liquidation Upon any liquidation, dissolution or winding-up of the Company, whether voluntary or involuntary (a “Liquidation”), the then holders of the Series A-1 Preferred Stock are entitled to receive out of the assets available for distribution to stockholders of the Company an amount equal to 100 % of the stated value, plus any accrued and unpaid dividends thereon and any other fees or liquidated damages then due and owing thereon, prior and in preference to the Common Stock or any other series of preferred stock (other than the Series A-2 Preferred Stock). Conversion The Series A-1 Preferred Stock is convertible into Common Stock at any time at a conversion price of $ 0.25 , subject to adjustment for certain anti-dilution provisions set forth in the Series A-1 Certificate of Designation (the “Series A-1 Conversion Price”). Upon conversion the shares of Series A-1 Preferred Stock will resume the status of authorized but unissued shares of preferred stock of the Company. Conversion at the Option of the Holder The Series A-1 Preferred Stock is convertible at the then-effective Series A-1 Conversion Price at the option of the holder at any time and from time to time. 13 Table of Contents SMARTKEM, INC. Notes to Condensed Consolidated Financial Statements ​ Mandatory Conversion at the Option of the Company ​ So long as certain equity conditions are satisfied, the Company may give notice requiring the holders to convert all of the outstanding shares of Series A-1 Preferred Stock into shares of Common Stock at the then-effective Series A-1 Conversion Price. Beneficial Ownership Limitation The Series A-1 Preferred Stock cannot be converted to Common Stock if the holder and its affiliates would beneficially own more than 4.99 % (or 9.99 % at the election of the holder) of the outstanding common stock. However, any holder may increase or decrease such percentage to any other percentage not in excess of 9.99 % upon notice to us, provided that any increase in this limitation will not be effective until 61 days after such notice from the holder to us and such increase or decrease will apply only to the holder providing such notice. Preemptive Rights No holders of Series A-1 Preferred Stock will, as holders of Series A-1 Preferred Stock, have any preemptive rights to purchase or subscribe for Common Stock or any of our other securities. Redemption The shares of Series A-1 Preferred Stock are not redeemable by the Company. Negative Covenants As long as any Series A-1 Preferred Stock is outstanding, unless the holders of more than 50 % in stated value of the then outstanding shares of Series A-1 Preferred Stock shall have otherwise given prior written consent (which must include AIGH for so long as AIGH is holding at least $ 1,500,000 in aggregate stated value of Series A-1 Preferred Stock acquired pursuant to the Purchase Agreement), the Company cannot, subject to certain exceptions, (a) enter into, create, incur, assume, guarantee or suffer to exist any indebtedness, (b) enter into, create, incur, assume or suffer to exist any liens, (c) repay, repurchase or offer to repay, repurchase or otherwise acquire more than a de minimis number of shares of its Common Stock, Common Stock equivalents or junior securities, (d) enter into any transaction with any affiliate of the Company which would be required to be disclosed in any public filing with the Commission, unless such transaction is made on an arm’s-length basis and expressly approved by a majority of the disinterested directors of the Company, (e) declare or pay a dividend on junior securities or (f) enter into any agreement with respect to any of the foregoing. Trading Market There is no established trading market for any of the Series A-1 Preferred Stock, and we do not expect a market to develop. We do not intend to apply for a listing for any of the Series A-1 Preferred Stock on any securities exchange or other nationally recognized trading system. Without an active trading market, the liquidity of the Series A-1 Preferred Stock will be limited. Series A-2 Preferred Stock On June 14, 2023, the Company filed a Certificate of Designation of Preferences, Rights and Limitations with the Secretary of State of the State of Delaware designating 18,000 shares out of the authorized but unissued shares of its preferred stock as Series A-2 Preferred Stock with a stated value of $ 1,000 per share (the “Series A-2 Certificate of Designation”). The following is a summary of the principal terms of the Series A-2 Preferred Stock as set forth in the Series A-2 Certificate of Designation: 14 Table of Contents SMARTKEM, INC. Notes to Condensed Consolidated Financial Statements ​ Dividends ​ The holders of Series A-2 Preferred Stock will be entitled to dividends, on an as-if converted basis, equal to and in the same form as dividends actually paid on shares of Common Stock, when and if actually paid. Voting Rights The shares of Series A-2 Preferred Stock have no voting rights, except to the extent required by the DGCL. As long as any shares of Series A-2 Preferred Stock are outstanding, the Company may not, without the approval of a majority of the then outstanding shares of Series A-2 Preferred Stock (a) alter or change the powers, preferences or rights of the Series A-2 Preferred Stock, (b) alter or amend the Charter, the Series A-2 Certificate of Designation or the Bylaws in such a manner so as to materially adversely affect any rights given to the Series A-2 Preferred Stock, (c) authorize or create any class of stock ranking as to dividends, redemption or distribution of assets upon a liquidation senior to, or otherwise pari passu with, the Series A-2 Preferred Stock or (d) enter into any agreement to do any of the foregoing. Liquidation Upon a Liquidation, the then holders of the Series A-2 Preferred Stock are entitled to receive out of the assets available for distribution to stockholders of the Company an amount equal to 100 % of the stated value, plus any accrued and unpaid dividends thereon and any other fees or liquidated damages then due and owing thereon, prior and in preference to the Common Stock or any other series of preferred stock (other than the Series A-1 Preferred Stock). Conversion The Series A-2 Preferred Stock is convertible into Common Stock at any time at a conversion price of $ 0.25 , subject to adjustment for certain anti-dilution provisions set forth in the Series A-2 Certificate of Designation (the “Series A-2 Conversion Price”). Upon conversion the shares of Series A-2 Preferred Stock will resume the status of authorized but unissued shares of preferred stock of the Company. Conversion at the Option of the Holder The Series A-2 Preferred Stock is convertible at the then-effective Series A-2 Conversion Price at the option of the holder at any time and from time to time. Automatic Conversion On the trading day immediately preceding the date on which shares of Common Stock commence trading on the NYSE American, the Nasdaq Capital Market, the Nasdaq Global Market, the Nasdaq Global Select Market or the New York Stock Exchange all, but not less than all, of the outstanding shares of Series A-2 Preferred Stock shall automatically convert, without any action on the part of the holder thereof and without payment of any additional consideration, into that number of shares of Common Stock determined by dividing the stated of such share of Series A-2 Preferred Stock by the then applicable Series A-2 Conversion Price. Beneficial Ownership Limitation The Series A-2 Preferred Stock cannot be converted to common stock if the holder and its affiliates would beneficially own more than 4.99 % (or 9.99 % at the election of the holder) of the outstanding common stock. However, any holder may increase or decrease such percentage to any other percentage not in excess of 9.99 % upon notice to us, provided that any increase in this limitation will not be effective until 61 days after such notice from the holder to us and such increase or decrease will apply only to the holder providing such notice. 15 Table of Contents SMARTKEM, INC. Notes to Condensed Consolidated Financial Statements ​ Preemptive Rights ​ No holders of Series A-2 Preferred Stock will, as holders of Series A-2 Preferred Stock, have any preemptive rights to purchase or subscribe for Common Stock or any of our other securities. Redemption The shares of Series A-2 Preferred Stock are not redeemable by the Company. Trading Market There is no established trading market for any of the Series A-2 Preferred Stock, and we do not expect a market to develop. We do not intend to apply for a listing for any of the Series A-2 Preferred Stock on any securities exchange or other nationally recognized trading system. Without an active trading market, the liquidity of the Series A-2 Preferred Stock will be limited. ​ Series A-1 and A-2 Preferred Stock and Class A and Class B Warrant Issuances ​ On June 14, 2023, the Company and certain investors entered into a securities purchase agreement (the “Purchase Agreement”) pursuant to which the Company sold an aggregate of (i) 9,229 shares of Series A-1 Convertible Preferred Stock at a price of $ 1,000 per share (the “Series A-1 Preferred Stock”), (ii) 2,950 shares of the Company’s Series A-2 Convertible Preferred Stock at a price of $ 1,000 per share (“Series A-2 Preferred Stock” and together with the Series A-1 Preferred Stock, the “Preferred Stock”), (iii) Class A Warrants to purchase up to an aggregate of 48,716,000 shares of common stock (the “Class A Warrant”), and (iv) Class B Warrants to purchase up to an aggregate of 27,943,860 shares of common stock (the “Class B Warrant” and together with the Class A Warrant, the “Warrants”) for aggregate gross proceeds of $ 12.2 million (the “June 2023 PIPE”). In addition, 1,200,000 Class B Warrants were issued in lieu of cash payments for consulting services related to the offering. The fair value of the service provided was $59 thousand. ​ On June 22, 2023, in a second closing of the June 2023 PIPE, the Company sold an aggregate of (i) 1,870.36596 Series A-1 Preferred Stock, (ii) 100 shares of Series A-2 Preferred Stock, and (iii) Class A Warrants to purchase up to an aggregate of 7,881,464 shares of Common Stock pursuant to the Purchase Agreement for aggregate gross proceeds of $ 2.0 million. In addition, 300,000 Class B Warrants were issued in lieu of cash payments for consulting services related to the offering. The fair value of the service provided was $15 thousand. ​ Each Class A Warrant has an exercise price of $ 0.25 and each Class B Warrant has an exercise price of $ 0.01 , both subject to adjustments in accordance with the terms of the Warrants. The Warrants expire five years from the issuance date. ​ There were an additional 4,464,118 warrants issues related to a placement agent fee. The fair value of this fee is $31 thousand. ​ The Company has accounted for the Class A and Class B Warrants as derivative instruments in accordance with ASC 815, Derivatives and Hedging. The Company classified the Warrants as a liability because they cannot be considered indexed to the Company’s stock due to provisions that, in certain circumstances, adjust the number of shares to be issued if the exercise price is adjusted and the existence of a pre-specified volatility input to the Black-Scholes calculation which could be used to calculate consideration in the event of a Fundamental Transaction, as defined in the agreements. ​ The Company received net proceeds after expenses of $ 12.7 million. Of the net proceeds, the Company allocated an estimated fair value of $ 1.8 million to the Warrants. The Company also expensed $0.2 million of issuance costs that were allocated to the warranty liability during the three and six months ended June 30, 2023. 16 Table of Contents SMARTKEM, INC. Notes to Condensed Consolidated Financial Statements ​ The terms of the June 2023 PIPE include a number of restrictions on our operations and on our ability to raise additional capital. The Purchase Agreement, among other things, provides that, for a period ending on June 14, 2024, we may not use cash from operating activities (as defined under U.S. generally accepted accounting principles) of more than an average of $ 2.8 million for any consecutive three-month period (subject to certain exceptions). This provision may cause us to delay certain actions that may benefit our business and may prevent us from pursuing potentially favorable business opportunities, even if a majority of our board of directors believes such actions or opportunities are in the best interest of our company and our stockholders. Under the terms of the Purchase Agreement, for a period ending on December 15, 2025, in the event that we issue common stock or common stock equivalents in a subsequent financing (as defined in the Purchase Agreement), the significant purchasers (defined in the Purchase Agreement as a purchaser acquiring at least 1,000 shares of Series A-1 Preferred Stock) will have the right to purchase up to 40 % of the securities sold in the subsequent financing. This provision may make it more difficult for us to raise additional capital because other investors may want to provide all or a larger portion of the capital provided in the subsequent financing or may be unwilling to co-invest with one or more of the significant purchasers or may be unwilling to commit to provide financing without knowing how much of the subsequent financing will be provided by the significant purchasers. In addition, during such period, we may not issue common stock or common stock equivalents in a subsequent financing with an effective price per share of common stock that is or may become lower than the then-effective conversion price of the Series A-1 Preferred Stock without the consent of the significant purchasers, which must include AIGH Investment Partners LP and its affiliates for so long as they are holding at least $ 1,500,000 in aggregate stated value of Series A-1 Preferred Stock acquired pursuant to the Purchase Agreement. This provision may prevent us from obtaining additional capital on market terms even if a majority of our board of directors believes that the terms of the subsequent financing are in the best interests of our company and our stockholders. This provision may also have the effect of increasing the cost of obtaining additional capital either because the significant purchasers refuse to consent to any such subsequent financing unless provided by them on terms approved by them or because we are required to provide additional consideration to such significant purchasers in exchange for their consent. In the event that we issue common stock or common stock equivalents in a subsequent financing prior to the time our common stock is listed on a national securities exchange, the Purchase Agreement provides that if a significant purchaser reasonably believes that any of the terms and conditions of the subsequent financing are more favorable to an investor in the subsequent financing than the terms of the June 2023 PIPE, such significant purchaser has the right to require us to amend the terms of the June 2023 PIPE to include such more favorable term for such significant purchaser. This provision may make it more expensive to obtain additional capital prior to an uplisting because it permits any significant purchaser to “cherry pick” the terms of the subsequent financing and to require any term deemed to be more favorable to be included retroactively in the terms of the June 2023 PIPE. This provision also potentially creates uncertainty around the terms of a subsequent financing because the significant purchasers have the right to review terms of a completed subsequent financing before deciding which, if any, of the terms thereof they find more favorable to them. The Purchase Agreement provides that, until June 14, 2025, a significant purchaser may participate in a subsequent transaction by exchanging some or all of its Series A-1 Preferred Stock having a stated value equal to its subscription amount in the subsequent financing. This provision may adversely affect the amount of capital we raise in a subsequent financing, as it permits a significant purchaser to roll its existing investment into the new financing rather than being required to invest cash. This provision also has the potential to make it more difficult for us to raise additional capital as other investors may want to provide all or a larger portion of the capital provided in the subsequent financing or may require us to raise a minimum amount of new capital or may be unwilling to commit to provide financing without knowing how much of the subsequent financing will be provided by the significant purchasers in cash. If we are unable to raise additional capital when needed, we may be required to delay, limit, reduce or terminate commercialization, our research and product development, or grant rights to develop and market our products that we would otherwise prefer to develop and market ourselves and may have a material adverse effect on our business, financial condition and results of operations. ​ 17 Table of Contents SMARTKEM, INC. Notes to Condensed Consolidated Financial Statements ​ 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, constitutes a quorum for the transaction of business at all meetings of the stockholders. Dividends The Company has never paid any cash dividends to stockholders and do not anticipate paying any cash dividends to stockholders in the foreseeable future. Any future determination to pay cash dividends will be at the discretion of our board of directors and will be dependent upon financial condition, results of operations, capital requirements and such other factors as the board of directors deems relevant. Market Information Quotations on our common stock on the OTC Market Group’s OTCQB® Market quotation system (“OTCQB”) commenced under the ticker symbol “SMTK” in February 2022. There was no trading of our common stock on the OTCQB or any other over-the-counter market prior to February 2022. Common Stock Issued to Vendors for Services On January 6, 2023, the Company issued 50,000 shares of common stock, as payment for investor relations and other financial consulting services. On February 27, 2023, the Company issued 52,777 shares of common stock as payment for investor relations services. Common Stock Warrants A summary of the Company’s warrants to purchase common stock activity is as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Weighted- ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Average ​ ​ ​ ​ ​ ​ ​ Weighted- ​ Remaining ​ ​ ​ ​ ​ ​ ​ Average ​ Contractual ​ ​ Number of ​ ​ Exercise Price ​ Exercise ​ Term ​ ​ Shares ​ ​ per Share ​ Price ​ (Years) Warrants outstanding at January 1, 2023 985,533 ​ ​ $ 2.00 ​ $ 2.00 3.15 Issued 90,505,442 ​ ​ ​ ​ ​ 0.17 Exercised — ​ ​ ​ ​ ​ Expired — ​ ​ ​ ​ ​ Warrants outstanding at June 30, 2023 91,490,975 ​ ​ $ 0.01 - $ 2.00 ​ $ 0.19 4.94 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ 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, 2023 2,168,000 ​ $ 0.01 ​ Issued — ​ ​ ​ Exercised — ​ ​ ​ Expired — ​ ​ ​ Pre-funded warrants outstanding at June 30, 2023 2,168,000 ​ $ 0.01 ​ 18 Table of Contents SMARTKEM, INC. Notes to Condensed Consolidated Financial Statements ​ ​ ​ ​ ​ ​ ​ ​ ​ For any grant dates prior to February 2022, the fair value of common stock warrants is determined using the Black Scholes option-pricing model. There was no public trading market for our shares before February 2022 and the Company estimates its expected stock volatility based on historical volatility of publicly traded peer companies. 9. SHARE-BASED COMPENSATION: On February 23, 2021, the Company approved the 2021 Equity Incentive Plan (“2021 Plan”), in which a maximum aggregate number of shares of common stock that may be issued under the 2021 Plan is 4,376,571 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. Determining the appropriate fair value of share-based awards requires the input of subjective assumptions, including the fair value of the Company’s common stock, 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 involve 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. There were no options granted under the 2021 Plan for the three and six months ended June 30, 2023 and 2022. Prior to February 2022, in the absence of a public trading market for the common stock, on each grant date, the Company developed an estimate of the fair value of the shares of common stock underlying the option grants. The Company estimated the fair value of the shares of common stock by referencing arms-length transactions inclusive of the shares of common stock underlying which occurred on or near the valuation date(s). The Company determined the fair value of the common stock using methodologies, approaches and assumptions consistent with the AICPA Practice Guide, Valuation of Privately Held Company Equity Securities Issued as Compensation and based in part on input from an independent third-party valuation firm. From February 2022, the Company’s common stock is publicly traded, and the Company no longer has to estimate the fair value of the shares of common stock, rather the value is determined based on quoted market prices. The Company estimates its expected volatility by using a combination of historical share price volatilities of similar companies within our industry. The risk-free interest rate assumption is based on observed interest rates for the appropriate term of the Company’s options on a grant date. The contractual term is 10 years , and the expected option term is lower. 19 Table of Contents SMARTKEM, INC. Notes to Condensed Consolidated Financial Statements ​ The following table reflects share activity under the share option plans for the six months ended June 30, 2023: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Weighted- ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Average ​ ​ ​ ​ ​ ​ ​ ​ ​ Weighted- ​ Remaining ​ Weighted- ​ Aggregate ​ ​ ​ ​ Average ​ Contractual ​ Average ​ Intrinsic ​ ​ Number of ​ Exercise ​ Term ​ Fair Value at ​ Value ​ ​ Shares ​ Price ​ (Years) ​ Grant Date ​ (in thousands) Options outstanding at January 1, 2023 2,829,756 $ 1.81 8.77 $ 0.98273 ​ ​ Exercised ​ — ​ ​ — ​ ​ ​ ​ ​ ​ ​ ​ Cancelled/Forfeited — — ​ ​ Expired ( 83,836 ) ( 1.37 ) ​ ​ Granted — — ​ ​ Options outstanding at June 30, 2023 2,745,920 $ 1.82 7.50 $ 0.97410 ​ ​ Options exercisable at June 30, 2023 ​ 1,294,692 ​ $ 1.62 ​ 6.10 ​ ​ ​ ​ $ 63 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Stock-based compensation is included in the unaudited interim condensed consolidated statements of operations as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Three Months Ended June 30, ​ Six Months Ended June 30, ​ (in thousands) ​ 2023 2022 2023 2022 ​ Research and development ​ $ 49 ​ $ 38 ​ $ 119 ​ $ 78 ​ Selling, general and administration ​ 70 ​ 59 ​ 293 ​ 117 ​ Total ​ $ 119 ​ $ 97 ​ $ 412 ​ $ 195 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Total compensation cost related to non-vested stock option awards not yet recognized as of June 30, 2023 was $ 1.1 million and will be recognized on a straight-line basis through the end of the vesting periods in July 2026. The amount of future stock option compensation expense could be affected by any future option grants or by any forfeitures. 10. NET LOSS PER COMMON SHARE: Basic net loss per share is determined by dividing net loss by the weighted average shares of common stock outstanding during the period, without consideration of potentially dilutive securities, except for those shares that are issuable for little or no cash consideration. Diluted net loss per share is determined by dividing net loss by diluted weighted average shares outstanding. Diluted weighted average shares reflects the dilutive effect, if any, of potentially dilutive common shares, such as stock options and warrants calculated using the treasury stock method. In periods with reported net operating losses, all common stock options and warrants are generally deemed anti-dilutive such that basic net loss per share and diluted net loss per share are equal. The following potentially dilutive securities were excluded from the computation of earnings per share as of June 30, 2023 and 2022 because their effects would be anti-dilutive: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ June 30, ​ 2023 ​ 2022 Common stock warrants ​ ​ 62,047,115 ​ ​ 985,533 Assumed conversion of preferred stock ​ ​ 56,597,464 ​ ​ — Stock options ​ ​ 2,745,920 ​ ​ 1,937,382 Total ​ ​ 121,390,499 ​ ​ 2,922,915 ​ ​ ​ ​ ​ ​ ​ ​ At June 30, 2023, the Company had 2,168,000 pre-funded warrants outstanding. The following table provides a reconciliation of the weighted average shares outstanding calculation for the three and six months ended June 30, 2023 and 2022: 20 Table of Contents SMARTKEM, INC. Notes to Condensed Consolidated Financial Statements ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Three Months Ended June 30, ​ Six Months Ended June 30, ​ ​ 2023 2022 2023 2022 Weighted average shares issued ​ ​ 27,087,773 ​ ​ 26,583,365 ​ ​ 27,083,982 ​ ​ 26,427,550 Weighted average pre-funded warrants ​ ​ 2,168,000 ​ ​ 2,168,000 ​ ​ 2,168,000 ​ ​ 2,168,000 Weighted average penny warrants ​ ​ 9,660,613 ​ ​ - ​ ​ 4,856,993 ​ ​ - Weighted average shares outstanding ​ ​ 38,916,386 ​ ​ 28,751,365 ​ ​ 34,108,976 ​ ​ 28,595,550 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ 11. DEFINED CONTRIBUTION PENSION: The Company operates a defined contribution pension scheme for its UK employees. The assets of the scheme are held separately from those of the Company in an independently administered fund. The pension cost charge represents contributions payable by the Company to the fund. Pension cost is included in the unaudited interim condensed consolidated statements of operations as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Three Months Ended June 30, ​ Six Months Ended June 30, ​ (in thousands) ​ 2023 2022 2023 2022 ​ Research and development ​ $ 22 ​ $ 26 ​ $ 44 ​ $ 53 ​ Selling, general and administration ​ 15 ​ 13 ​ 33 ​ 27 ​ Total ​ $ 37 ​ $ 39 ​ $ 77 ​ $ 80 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ 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 quarter ended June 30, 2023: ​ ​ ​ ​ ​ (in thousands) ​ Warrant Liability Balance at January 1,2023 ​ $ — Fair value of warrant issued in Private Placement Offering ​ ​ 1,837 Total change in the liability included in earnings ​ ( 3 ) Balance at June 30, 2023 ​ $ 1,834 ​ ​ ​ ​ ​ As disclosed in Note 7 of the Company’s consolidated financial statements, the Company allocated part of the proceeds of private placement of the Company’s preferred A-1 and A-2 shares 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 have used an expected volatility based on historical common stock volatility of our peers. The Company has accounted for them as derivative instruments in accordance with ASC 815, adjusting the fair value at the end of each reporting period. ​ The fair value of the preferred and common warrants at June 30, June 22 and June 14, 2023 was determined by using option pricing models assuming the following: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ June 30, ​ June 22 ​ June 14 ​ ​ 2023 ​ 2023 ​ 2023 Expected term (years) ​ 4.96 ​ ​ 5.00 ​ ​ 5.00 Risk-free interest rate ​ 4.05 % ​ ​ 3.95 % ​ ​ 3.98 % Expected volatility ​ 50.0 % ​ ​ 50.0 % ​ ​ 50.0 % Expected dividend yield ​ 0.0 % ​ ​ 0.0 % ​ ​ 0.0 % Underlying stock price ​ ​ $ 0.06 ​ ​ $ 0.06 ​ ​ $ 0.06 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ 21 Table of Contents SMARTKEM, INC. Notes to Condensed Consolidated Financial Statements ​ Additionally, the Company has 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. ​ The following tables present information about the Company’s financial assets and liabilities that have been measured at fair value as of June 30, 2023 and indicate the fair value hierarchy of the valuation inputs utilized to determine such fair value. In general, the fair values were determined using Level 3: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Quoted Prices in ​ Significant Other ​ Significant ​ ​ ​ ​ ​ Active Markets ​ Observable Inputs ​ Unobservable Inputs ​ June 30, ​ ​ (Level 1) ​ (Level 2) ​ (Level 3) ​ 2023 Description ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Liabilities: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Warrant liability ​ $ — ​ $ — ​ $ 1,834 ​ $ 1,834 Total liabilities ​ $ — ​ $ — ​ $ 1,834 ​ $ 1,834 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ 13. SUBSEQUENT EVENTS: Warrant Exercises Subsequent to June 30, 2023, warrants to purchase 2,500,000 shares of the Company’s common stock with an exercise price of $ 0.01 per share were exercised for proceeds of $ 25,000 . Preferred Stock Conversions Subsequent to June 30, 2023, the Company issued 800,000 shares of the Company’s common stock upon the conversion of 200 Series A-2 Preferred Stock. ​ 22 Table of Contents ​