Washington, D.C. 20549
Indicate by check mark if the registrant is a well-known seasoned
issuer as defined in Rule 405 of the Securities Act
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or 15(d) of the Exchange Act.
Indicate by check mark whether the registrant: (1) has filed
all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements
for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically
and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule
405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and
post such files)
Indicate by check mark if disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K.
¨
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer.
Indicate by check mark whether the registrant is a shell company
(as defined by Rule 12b-2 of the Act). Yes
¨
No
x
As of June 30, 2016, the last business day of the
registrant’s most recently completed second fiscal quarter, the aggregate value of the registrant’s common stock
(excluding the 6,547,234 shares held by affiliates), based upon the $0.81 price at which such common stock was last sold on
June 30, 2016, was approximately $56.3 million.
As of March 8, 2017, there were 90,698,113 shares of common
stock issued and outstanding.
Portions of the registrant's Proxy Statement
for its 2017 Annual Meeting of Stockholders are incorporated herein by reference in Part III of this Annual Report on Form 10-K.
Such Proxy Statement will be filed with the Securities and Exchange Commission within 120 days of December 31, 2016.
This Annual Report on Form 10-K contains
forward-looking statements concerning our business, operations and financial performance and condition as well as our plans, objectives
and expectations for our business operations and financial performance and condition that are subject to risks and uncertainties.
All statements other than statements of historical fact included in this Annual Report on Form 10-K are forward-looking statements.
You can identify these statements by words such as “aim,” “anticipate,” “assume,” “believe,”
“could,” “due,” “estimate,” “expect,” “goal,” “intend,”
“may,” “objective,” “plan,” “potential,” “positioned,” “predict,”
“should,” “target,” “will,” “would” and other similar expressions that are predictions
of or indicate future events and future trends. These forward-looking statements are based on current expectations, estimates,
forecasts and projections about our business and the industry in which we operate and our management's beliefs and assumptions.
These statements are not guarantees of future performance or development and involve known and unknown risks, uncertainties and
other factors that are in some cases beyond our control. All forward-looking statements are subject to risks and uncertainties
that may cause actual results to differ materially from those that we expected, including:
For the discussion of these risks and uncertainties
and others that could cause actual results to differ materially from those contained in our forward-looking statements, please
refer to “Risk Factors” in this Annual Report on Form 10-K. The forward-looking statements included in this Annual
Report on Form 10-K are made only as of the date hereof. We undertake no obligation to publicly update or revise any forward-looking
statement as a result of new information, future events or otherwise, except as otherwise required by law.
Unless the context otherwise requires,
references to the “Company” “we” “us” and “our” refer to 22nd Century Group, Inc.,
a Nevada corporation, and its direct and indirect subsidiaries.
PART I
Background
22nd Century Group, Inc. was incorporated
under the laws of the State of Nevada on September 12, 2005 under the name Touchstone Mining Limited. On January 25, 2011, we entered
into a reverse merger transaction with 22nd Century Limited, LLC, which we refer to herein as the “merger.” Upon the
closing of the merger, 22nd Century Limited, LLC became our wholly-owned subsidiary. After the merger, we succeeded to the business
of 22nd Century Limited, LLC as our sole line of business.
22nd Century Limited, LLC was originally
formed as a New York limited liability company on February 20, 1998 as 21st Century Limited, LLC and subsequently merged with a
newly-formed Delaware limited liability company, 22nd Century Limited, LLC, on November 29, 1999. Since inception, 22nd Century
Limited, LLC has sponsored research and subsequently used biotechnology to regulate the nicotine content in tobacco plants.
Overview
We are a plant biotechnology company focused
on technology that allows us to increase or decrease the level of nicotine and other nicotinic alkaloids in tobacco plants and
levels of cannabinoids in cannabis plants through genetic engineering and plant breeding. Our primary mission is to reduce the
harm caused by smoking. We own or exclusively control more than 200 issued patents plus more than 50 pending patent applications.
We are in the process of transitioning
from researching and developing our proprietary technology and tobaccos to commercializing our technology and products. We initiated
the commercialization of our technology and products in the year 2015. According to Euromonitor International, annual worldwide
tobacco product sales, including cigarettes and smokeless products, are approximately $800 billion, most of which are cigarette
sales. If we, or our licensee(s), capture a small fraction of this market, we believe our value will increase tremendously.
We are primarily involved in the following
activities:
|
·
|
The research and development
of potentially less harmful or modified risk tobacco products and novel tobacco plant varieties;
|
|
·
|
The pursuit of necessary
regulatory approvals and clearances from the FDA to market
BRAND A
cigarettes in the U.S. as an over-the-counter
product labeled to advertise the reduced exposure to nicotine, as
BRAND A
cigarettes contain 95% less nicotine than conventional
tobacco cigarettes;
|
|
·
|
The development of
X-22
,
a prescription-based smoking cessation aid consisting of very low nicotine (“VLN”) cigarettes, and the pursuit of
regulatory approvals and clearances from the FDA and regulatory agencies in other countries to market
X-22
as a prescription
smoking cessation aid;
|
|
·
|
The pursuit of necessary
regulatory approvals and clearances from the FDA to market
BRAND B
cigarettes as modified risk cigarettes with an extremely
low tar-to-nicotine ratio;
|
|
·
|
The manufacture, marketing,
sales and distribution of
RED SUN
and
MAGIC
proprietary cigarettes;
|
|
·
|
The production of
SPECTRUM
research cigarettes for the National Institute on Drug Abuse (“NIDA”), a part of the National Institutes of Health
(“NIH”);
|
|
·
|
The international licensing
of our technology, proprietary tobaccos, and trademarks;
|
|
·
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The sale of our branded
proprietary tobaccos;
|
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·
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The contract manufacturing
of third-party branded tobacco products; and
|
|
·
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The research and development
of unique plant varieties of hemp/cannabis, such as (i) plants with low to no amounts of delta-9-tetrahydrocannabinol, or THC,
for the legal hemp industry, and (ii) plants with high levels of cannabidiol, or CBD, and other non-THC cannabinoids for the legal
medical cannabis markets.
|
Our prospects depend on our ability
to generate and sustain revenues from (i) licensing and/or sale of our proprietary tobacco, technology and products; (ii)
regulatory approval of our
X-22
smoking cessation aid; (iii) further development of our potential modified risk
tobacco products; (iv) domestic and international sales of our brands, including
RED SUN
and
MAGIC
; and (v)
the manufacture of the filtered cigar and cigarette brands of third-parties at our manufacturing facility in North Carolina.
Our ability to generate meaningful revenue from our potential modified risk tobacco products in the United States depends on
obtaining FDA authorization to market these products as modified risk or reduced exposure; and our ability to generate
meaningful revenue in the United States from
X-2
2 depends on FDA approval. If these products are authorized and
approved by the FDA, we must still meet the challenges of successful marketing, distribution and consumer acceptance.
We believe our products address unmet
needs of smokers; for those smokers who desire to quit, an innovative smoking cessation aid, and for those smokers who are
unable or unwilling to quit smoking, cigarettes that may reduce the level of exposure to nicotine and certain tobacco toxins.
We believe our proprietary
technology, tobaccos and products will generate multiple significant revenue streams from the licensing of our technology and
tobacco and from the sales of our products.
Intellectual Property
Our intellectual property enables us
to decrease or increase the level of nicotine and other nicotinic alkaloids in tobacco plants by decreasing or increasing the
expression of the gene(s) responsible for nicotine production in the tobacco plant using genetic engineering. The basic
techniques include, but are not limited to, those that are used in the production of genetically modified (“GM”)
varieties of other crops, which are also known as “biotech crops.”
We own or exclusively control more
than 200 issued patents plus more than 50 pending patent applications. A “patent family” is a set of patents
granted in various countries to protect a single invention. Our patent coverage in the United States and China, two of the
most valuable smoking cessation and cigarette markets in the world, consists of 29 issued patents and 21 pending applications
and 10 issued patents and 8 pending patent applications, respectively. We have exclusive rights to all uses of the following
genes responsible for nicotine content in tobacco plants:
NBB
,
QPT
,
A622
,
MPO
and several
transcription factor genes. We have exclusive rights to plants with altered nicotine content produced from modifying
expression of these genes and tobacco products produced from these plants. With the exception of one patent family that
will expire in 2018, the majority of the patent families related to nicotine biosynthesis will expire between 2021 and 2034,
with certain extensions of terms in the U.S. applications resulting from patent term adjustments at the U.S. Patent
and Trademark Office.
In September 2014, we entered into a Sublicense
Agreement with Anandia Laboratories, Inc. (the “Anandia Sublicense”). Under the terms of the Anandia Sublicense, we
were granted an exclusive sublicense in the United States and a co-exclusive sublicense in the remainder of the world, excluding
Canada, to 2 U.S. patents and 23 patent applications relating to four genes in the cannabis plant that are required for the production
of cannabinoids, the active ingredients in the cannabis plant. The Anandia Sublicense continues through the life of the last-to-expire
patent, which is expected to be in 2035. As a plant biotechnology company, our entry into the legal hemp/cannabis markets is a
natural evolution of our activities in a plant that has important research and commercial value and applications. We intend to
engage in research and development activities to create unique plant varieties of hemp/cannabis, such as (i) plants with
low to no amounts of THC for the legal hemp industry, and (ii) plants with high levels of CBD and other non-THC cannabinoids for
the legal medical cannabis markets.
We own various registered
trademarks in the United States and around the world. We also have exclusive plant variety rights in the United States (plant
variety protection certificates are issued by the U.S. Department of Agriculture (“PVP”)) and Canada. A PVP
certificate prevents anyone other than the owner/licensee from planting, propagating, selling, importing and exporting a
plant variety for twenty (20) years in the U.S. and generally for twenty (20) years in other member countries of the
International Union for the Protection of New Varieties of Plants, known as UPOV, an international treaty concerning plant
breeders’ rights. There are currently more than 70 countries that are members of UPOV.
Licensing our technology and tobacco
We have been in negotiations with various
parties in the tobacco and pharmaceutical industries for licensing our technology and products. On October 1, 2013, our subsidiary,
22nd Century Limited, LLC (“22nd Century Ltd.”), entered into a Research License and Commercial Option Agreement (the
“BAT Research Agreement”) with British American Tobacco (Investments) Limited (“BAT”), a subsidiary of
British American Tobacco plc.
Under the terms of the BAT Research Agreement,
BAT receives an exclusive worldwide license to certain patent rights (subject to worldwide rights retained by 22nd Century Ltd.
for use in its own brands and products) and licensed intellectual property rights (as such terms are defined in the BAT Research
Agreement) of 22nd Century Ltd. within the field of use (as defined in the BAT Research Agreement) for a period of up to four (4)
years (the “Research Term”). During the Research Term, BAT also has an option, which can be exercised by BAT at any
time during the Research Term, to obtain an exclusive worldwide license (subject to worldwide rights retained by 22nd Century Ltd.
for use in its own products and brands) to commercialize certain products derived from utilizing the patent rights and licensed
intellectual property rights under the terms of a commercial license agreement (the “Commercial License”).
Simultaneously with the signing of
the BAT Research Agreement, BAT paid us a non-refundable fee of $7.0 million. Further, we may receive payments from BAT of
up to an additional $7.0 million during the Research Term in the event certain milestones are met by BAT with respect to its
research and development of the patent rights and licensed intellectual property rights. There are four separate
milestones, two of which may result in BAT paying us $2.0 million for each milestone achieved, and two of which may result
in BAT paying us $1.5 million for each milestone achieved. BAT may terminate the BAT Research Agreement at
any time, subject to the requirements for certain payments to us by BAT upon termination as set forth
therein. We may also terminate the BAT Research Agreement in the event of certain uncured breaches of the
BAT Research Agreement as set forth therein.
BAT also granted to us a
worldwide license to any and all registered research results (as such term is defined in the BAT Research Agreement) developed
and owned by BAT which results or arises from any research, development or other activities of BAT under the BAT Research Agreement,
with the terms of such license from BAT. (i) to be on commercially reasonable terms to be negotiated in good
faith between the parties but, in any event, on terms which are no more onerous than the terms of the Commercial License, if any,
and (ii) to be dependent on what, if any, research results the Company elects to license.
If BAT exercises the option for a worldwide
Commercial License, BAT is required to pay us $3.0 million in aggregate annual license fees over a 2-year ramp-up
period, and thereafter a royalty, subject to annual minimums and maximums contained in the Commercial License, of (i) $100 per
metric ton of licensed tobacco that is supplied to, or grown and ready for shipment to, BAT and its affiliates (other than Reynolds
American, Inc. and Reynolds’ affiliates) and all other third parties; and (ii) $200 per metric ton of licensed tobacco supplied
to, or grown and processed by, BAT’s affiliate Reynolds American, Inc. and Reynolds’ affiliates.
Beginning three years from the start of
the Commercial License, both we and BAT may license/sublicense rights to any unaffiliated third party for use of
the technology outside the United States and we and BAT will equally share all profit from all such licensees/sublicensees.
Inside the United States, BAT may only sublicense BAT’s commercial rights to Reynolds American, Inc. we may
sublicense any party in the United States.
RED SUN and MAGIC Cigarettes
Our subsidiary, Goodrich Tobacco
Company, LLC (“Goodrich Tobacco”), introduced in a limited capacity two super-premium priced cigarette brands,
RED SUN
and
MAGIC
, into the U.S. market in the first quarter 2011. From the year 2011 through the year 2014, there
were
de minimis
sales of these brands since we intentionally did not expand the marketing and distribution of these
brands until after the Company became a subsequent participating manufacturer under the Master Settlement Agreement
(“MSA”), which occurred on August 29, 2014, when the 46 Settling States under the MSA approved the
Company’s acquisition of NASCO Products, LLC (“NASCO”), allowing us to become a subsequent
participating manufacturer under the MSA. During the remainder of 2014, the Company worked to obtain approvals from
regulatory agencies in all 50 States to have our
RED SUN
super-premium brand listed on the state directories of
tobacco products approved for sale in each such state. During 2014, we also worked with Orion, a cigarette manufacturer in
Poland, to contract manufacture the Company’s proprietary tobacco products for distribution in the European Union,
starting with our
MAGIC
super-premium brand. Both of the
RED SUN
and
MAGIC
brands are available in
regular and menthol and all brand styles are king size and packaged in hinge-lid hard packs. Since 2015, we have focused our
marketing efforts for
RED SUN
on national and regional distributors, tobacconists, smokeshops and other tobacco
outlets in the U.S. Since 2015, we also introduced our
MAGIC
cigarettes to distributors and retailers in select
European markets, as explained in greater detail below under “International Sales.”
MSA Membership
In September 2013, the Company entered
into a Membership Interest Purchase Agreement to purchase all of the issued and outstanding membership interests of NASCO, a federally
licensed tobacco product manufacturer and subsequent participating manufacturer under the MSA (the “NASCO Acquisition”).
On August 29, 2014, the Company entered into an Amended Adherence Agreement with the 46 Settling States under the MSA pursuant
to which the Company was approved to acquire NASCO and become a subsequent participating manufacturer under the MSA. On that same
date, the Company closed the NASCO Acquisition and became a subsequent participating manufacturer under the MSA. NASCO is now a
wholly-owned subsidiary of the Company.
Manufacturing
We lease a cigarette
manufacturing facility and warehouse located in Mocksville, North Carolina. In 2013 we purchased certain (i) cigarette
manufacturing equipment, and (ii) equipment parts, factory items, office furniture and fixtures, vehicles and computers from
the bankruptcy estate of PTM Technologies, Inc. (“PTM”) for $3.22 million.
The facility was primarily in a pre-manufacturing
stage during 2014 as we sought approval during that time for the Company to become a subsequent participating manufacturer under
the MSA. Since August 29, 2014, the Company manufacturers its cigarette brands in the United States through its wholly-owned subsidiary,
NASCO, at the Company’s factory in North Carolina. Since 2015, we have manufactured and sold our
SPECTRUM
government
research cigarettes, our
RED SUN
super-premium brand, together with a third-party MSA cigarette brand, and third-party filtered
cigars, at our factory.
The Company outsources
the manufacturing of
MAGIC
super-premium brand to Orion, a cigarette manufacturer in Poland that contract
manufactures
MAGIC
cigarettes for the Company for distribution in the European Union. Orion is a manufacturer and
distributor of smoking tobaccos, cigarettes, filter tubes, and smoking accessories with distribution in more than 20
countries. Distribution of
MAGIC
brand cigarettes commenced in Spain in 2015. In advance of expanding sales of
MAGIC
brand cigarettes in additional European countries and in Asia, the Company is pursuing, on a country-by-country basis, the
regulatory approvals associated with marketing to consumers the unique benefits of Very Low Nicotine cigarettes.
The Tobacco Control Act and Our Potentially
Modified Risk Cigarettes - BRAND A and BRAND B
In a 2005 analyst report,
The Third
Innovation, Potentially Reduced Exposure Cigarettes
, JP Morgan examined the effects of regulation by the U.S. Food and Drug
Administration (“FDA”) of tobacco, including the market for safer cigarettes. JP Morgan’s proprietary survey
of over 600 smokers found that 90% of smokers are willing to try a safer cigarette. Among JP Morgan’s other conclusions,
it stated: “FDA oversight would imbue PREPS [‘potential reduced exposure products’ which essentially equate to
potential modified risk tobacco products] with a regulatory ‘stamp of approval’ and allow for more explicit comparative
health claims with conventional cigarettes. Consumers should trust the FDA more than industry health claims.” Prior to the
Family Smoking Prevention and Tobacco Control Act (“Tobacco Control Act”) becoming law in 2009, no regulatory agency
or body had the authority to assess potentially modified risk tobacco products.
The Tobacco Control Act grants the FDA
authority over the regulation of all tobacco products. While the Tobacco Control Act prohibits the FDA from banning cigarettes
outright, it allows the FDA to require the reduction of nicotine or any other compound in tobacco and cigarette smoke. The Tobacco
Control Act also banned all sales in the U.S. of cigarettes with characterizing flavors (other than menthol). As of June 2010,
all cigarette companies were required to cease the use of the terms “low tar,” “light” and “ultra-light”
in describing cigarettes sold in the U.S. Besides numerous other regulations, including certain marketing restrictions, for the
first time in history, a U.S. regulatory agency now scientifically evaluates cigarettes that may pose lower health risks as compared
to conventional cigarettes.
The Tobacco Control Act establishes procedures
for the FDA to regulate the labeling and marketing of modified risk tobacco products, which includes cigarettes that (i) reduce
exposure to tobacco toxins and (ii) are reasonably likely to pose lower health risks, as compared to conventional cigarettes (“Modified
Risk Cigarettes”). The Tobacco Control Act required the FDA to issue specific regulations and guidance regarding applications
submitted to the FDA for the authorization to label and market Modified Risk Cigarettes. On March 30, 2012, the FDA issued
Modified
Risk Tobacco Product Applications Draft Guidance.
We believe that two types of our cigarettes in development, which we refer
to as
BRAND A
and
BRAND B
, may qualify as Modified Risk Cigarettes. In addition, the Tobacco Control Act allows the
FDA to mandate the use of reduced risk technologies in conventional tobacco products and cigarettes (e.g., Marlboro
®
,
Camel
®
, Newport
®
, Natural American Spirit
®
), which could create opportunities for
us to license our proprietary technology and/or our tobaccos to larger competitors.
We believe that our
BRAND
A
and
BRAND B
cigarettes will benefit smokers who are unable or unwilling to quit smoking and who may be
interested in cigarettes which reduce exposure to nicotine or to certain tobacco smoke toxins and/or pose a lower health risk
than conventional cigarettes. This includes approximately one-half of the 42 million adult smokers in the United States who
do not attempt to quit in a given year. Compared to commercial cigarettes, the tobacco in
BRAND A
has approximately
95% less nicotine than tobacco in cigarettes previously marketed as “light” cigarettes and
BRAND B
’s smoke contains an extraordinarily low amount of “tar” per milligram of nicotine. We believe
that
BRAND A
and
BRAND B
will achieve market share in the global cigarette market among smokers who are
unable or unwilling to quit but are interested in reducing the harmful effects of smoking. We believe this new regulatory
environment represents a paradigm shift for the tobacco industry. There is no guarantee, however, that we will (i) have
sufficient capital to complete the FDA authorization process for our potential Modified Risk Cigarettes, (ii) obtain FDA
authorization to market
BRAND A or
BRAND B
as Modified Risk Cigarettes, or (iii) achieve significant share of
the market even with FDA authorization to market our products as Modified Risk Cigarettes.
We have worked diligently with the
FDA to obtain a reduced exposure marketing authorization for
BRAND A
to be marketed as having less nicotine in the
U.S., as described below. We also intend to seek FDA authorization to (i) market
BRAND B
as a Modified
Risk Cigarette with an extraordinarily low amount of “tar” per milligram of nicotine and (ii) market
X-22
as a prescription smoking cessation product.
BRAND A Cigarettes
Compared to commercial tobacco cigarettes,
BRAND A
has the lowest nicotine content. The tobacco in
BRAND A
contains approximately 95% less nicotine than conventional
cigarette brands. Reducing smokers’ exposure to
nicotine is the strategy behind
BRAND A
.
In a June 16, 2010 press release, Dr. David
Kessler, the former FDA Commissioner, recommended that “the FDA should quickly move to reduce nicotine levels in cigarettes
to non-addictive levels. If we reduce the level of the stimulus, we reduce the craving. It is the ultimate harm reduction strategy.”
Shortly thereafter in a
Washington Post
newspaper article, Dr. Kessler said that the amount of nicotine in a cigarette should
drop from about 10 milligrams to less than 1 milligram.
BRAND A
cigarettes contain approximately 0.7 milligrams of nicotine
in the tobacco contained in the cigarette and a machine smoking yield of less than 0.05 mg of nicotine per cigarette.
The best-known clinical trial
utilizing our proprietary VLN tobacco was reported on in the October 2015 issue of
The New England Journal of Medicine
(N Engl J Med 2015; 373:1340-1349), which was funded by the National Institute on Drug Abuse (“NIDA”), which is
part of the National Institutes of Health (“NIH”), and the U.S. Food and Drug Administration (“FDA”)
Center for Tobacco Products (“CTP”). The Center for the Evaluation of Nicotine in Cigarettes led the double-blind, parallel,
randomized clinical trial involving 840 smokers at ten locations. The authors concluded that data from the study suggests, as
compared with cigarettes of conventional nicotine content, 22nd Century’s proprietary VLN cigarettes were
“associated with reductions in smoking, nicotine exposure, and nicotine dependence, with minimal evidence of nicotine
withdrawal, compensatory smoking, or serious adverse events.”
On December 31, 2015, we submitted to
the FDA a Modified Risk Tobacco Product application requesting a reduced exposure marketing authorization from the FDA to
market
BRAND A
as a Modified Risk Cigarette with product labeling and advertising that states that
BRAND A
has
95% less nicotine than conventional cigarettes. In December 2016, the FDA provided us with helpful and positive feedback on
our combined Modified Risk Tobacco Product Applications (MRTPAs) and Premarket Tobacco Product Applications (PMTAs) for our
BRAND
A
Very Low Nicotine tobacco cigarettes. In response to the FDA’s requests, and in conjunction with additional
clarifying guidance, we withdrew our existing application with the FDA in order to file new MRTPAs and PMTAs for
BRAND
A
that will include additional scientific data and information from already completed clinical studies on our Very Low
Nicotine tobacco cigarettes, in addition to smoking cessation research as requested by the FDA. In order to help further
expedite the FDA review process, we also intend to bifurcate our application into separate PMTAs and MRTPAs for
BRAND
A,
as PMTAs have shorter review periods.
We believe
BRAND A
will ultimately
receive a marketing order from the FDA to allow
BRAND A
to be marketed and sold in the U.S. as a reduced exposure product
that exposes users to 95% less nicotine than conventional cigarettes
.
BRAND B Cigarettes
Using a proprietary high
nicotine tobacco blend in conjunction with specialty cigarette components,
BRAND B
allows the smoker to achieve a
satisfactory amount of nicotine per cigarette while inhaling less “tar” and carbon monoxide. At the same time, we
do not expect exposure to nicotine from
BRAND B
to be significantly higher than some commercially available full
flavor cigarette brands. We believe smokers who desire to reduce smoke exposure, but are less concerned about nicotine, will
find
BRAND B
beneficial. Although smoking yields, as determined by laboratory smoking machines, are not always
indicative of smoke and tar intake by humans,
BRAND B
cigarettes are being designed to have a “tar” yield
between typical “light” and “ultra-light” cigarettes (as previously labeled and marketed by
conventional tobacco companies), but a nicotine yield of typical full flavor cigarettes.
In a 2001 report, entitled
Clearing the Smoke, Assessing the Science Base for Tobacco Harm Reduction
, the Institute of Medicine (the health arm of
the National Academy of Sciences) notes that a low “tar”/moderate nicotine cigarette is a viable strategy for
reducing the harm caused by smoking. The report states: “Retaining nicotine at pleasurable or addictive levels while
reducing the more toxic components of tobacco is another general strategy for harm reduction.” We believe that
evaluation of
BRAND B
in short-term human exposure studies will confirm that exposure to smoke, including certain
tobacco smoke toxins and carbon monoxide, is significantly reduced when smoking
BRAND B
as compared to smoking the
leading brands of cigarettes.
Accordingly, 22nd Century has submitted
an application with the FDA for the Company’s first proposed smoke evaluation exposure study for our
BRAND B
cigarettes.
The Company has engaged a major contract research organization (“CRO”) with extensive experience in tobacco exposure
studies to assist us in certain regulatory activities at the CTP related to the Company’s research to support the development
of potentially less harmful or modified risk cigarettes. Our first proof of concept study for
BRAND B
is scheduled for the second quarter of 2017, subject to completion of FDA review.
We believe results from this and other
exposure studies will warrant a modified risk claim for
BRAND B
.
X-22 Smoking Cessation Aid
X-22
is a tobacco-based
botanical medical product for use as an aid to smoking cessation. The
X-22
therapy protocol utilized in our sponsored
Phase IIb clinical trial calls for the patient to smoke our
X-22
cigarettes over a six-week treatment period to
facilitate the goal of the patient quitting smoking by the end of the treatment period. We believe this therapy protocol has
been successful in independent clinical trials because
X-22
cigarettes made from our proprietary tobacco satisfy
smokers’ cravings for cigarettes while (i) greatly reducing nicotine exposure and nicotine dependence and (ii)
extinguishing the association between the act of smoking and the rapid delivery of nicotine.
X-22
involves the same
smoking behavior as conventional cigarettes and because patients are simply switching to cigarettes with a
low
nicotine content
for 6 weeks,
X-22
does not expose the smoker to any new drugs or new side effects.
In fact, independent clinical studies
have demonstrated that smokers who smoke very low nicotine (“VLN”) cigarettes containing our proprietary tobacco
smoke fewer cigarettes per day resulting in significant reductions in smoke exposure, including “tar,” nicotine
and carbon monoxide. Due to the very low nicotine levels, compensatory smoking does not occur with VLN cigarettes containing
our proprietary tobacco (Hatsukami
et al
. 2010).
The independent, clinical studies utilizing
our proprietary tobacco cigarettes have shown efficacy when used alone and/or when used in conjunction with existing nicotine
replacement therapies (“NRTs”), such as the nicotine patch, gum or lozenge, or Pfizer’s Chantix/Champix product.
These clinical studies are all summarized below under “Business - Products -
X-22
Smoking Cessation Aid.” The
results of such clinical studies using cigarettes made from our Company’s proprietary VLN tobacco have demonstrated many
desirable outcomes, including reduced smoking, reduced nicotine exposure, reduce nicotine dependence, increased abstinence, reduced
exposure to toxicants and few adverse events with little evidence of withdrawal-related discomfort or safety concerns. Unlike
“light” cigarettes (as previously labeled and marketed by conventional tobacco companies) which reduce machine-smoking
nicotine yields by diluting the smoke rather than by reducing the nicotine content of the tobacco itself, VLN cigarettes do not
result in compensatory smoking.
The best-known clinical trial utilizing
our proprietary VLN tobacco was reported on in the October 2015 issue of
The New England Journal of Medicine
(N Engl J Med
2015; 373:1340-1349), which was funded by the National Institute on Drug Abuse (“NIDA”), which is part of the National
Institutes of Health (“NIH”), and the U.S. Food and Drug Administration (FDA) Center for Tobacco Products. The Center
for the Evaluation of Nicotine in Cigarettes led the double-blind, parallel, randomized clinical trial involving 840 smokers at
ten locations. The authors concluded that data from the study suggests, as compared with cigarettes of conventional nicotine content,
22nd Century’s proprietary VLN cigarettes were “associated with reductions in smoking, nicotine exposure, and nicotine
dependence, with minimal evidence of nicotine withdrawal, compensatory smoking, or serious adverse events.” The study’s
lead author, Dr. Eric Donny, explained that "The evidence is getting stronger that reducing nicotine reduces smoking and makes
people less addicted to cigarettes and, in doing so, might make them more likely to quit."
Approximately 50% of U.S. smokers attempt
to quit smoking each year, but only 2% to 5% actually quit smoking in a given year. It takes smokers an average of 8 to 11 “quit
attempts” before achieving long-term success. Approximately 95% of “self-quitters” (i.e., those who attempt to
quit smoking without any treatment) relapse and resume smoking. The Institute of Medicine, the health arm of the National Academy
of Sciences, in a 2007 report concludes: “There is an enormous opportunity to increase population prevalence of smoking cessation
by reaching and motivating the 57 percent of smokers who currently make no quit attempt per year.” We believe that our
X-22
smoking cessation aid will be attractive to smokers who have been frustrated in their previous attempts to quit smoking
using other therapies.
Use of existing smoking cessation aids
results in relapse rates that can be as high as 90% in the first year after a smoker initially “quits.” Smokers currently
have the following limited choices of FDA-approved products to help them quit smoking:
|
·
|
varenicline (Chantix
®
/Champix
®
outside the U.S.), manufactured by Pfizer Inc.,
|
|
·
|
bupropion (Zyban
®
),
manufactured by GlaxoSmithKline plc, and
|
|
·
|
nicotine replacement
therapy which is available in the U.S. in several forms: gums, patches, nasal sprays, inhalers and lozenges.
|
Chantix
®
and Zyban
®
are pills and are nicotine free. Chantix
®
, Zyban
®
, the nicotine nasal spray and the nicotine inhaler
are available by prescription only in the U.S. Nicotine gums, nicotine patches, and nicotine lozenges are available over-the-counter
in the U.S.
Chantix
®
was
introduced in the U.S. market in the fourth quarter 2006. Since 2007, Chantix
®
has been the best-selling
smoking cessation aid in the United States, with sales, according to Pfizer Inc., of approximately $701 million in 2007, $489
million in 2008, $386 million in 2009, $330 million in 2010, $326 million in 2011, $313 million in 2012, $343 million in 2013
$377 million in 2014, and $426 million in 2015. In July 2009, the FDA required a “Boxed Warning,” the most
serious type of warning in prescription drug labeling, for both Chantix
®
and Zyban
®
based on
the potential side effects of these drugs. Despite this Boxed Warning (which was subsequently eliminated on December 16, 2016),
worldwide sales of Chantix
®
in 2009 to 2015 were approximately $700 million, $755 million, $720 million, $670
million, $648 million, $647 million, and $671 million, respectively.
Other than Chantix
®
and
Zyban
®
, the only FDA-approved smoking cessation therapy in the United States is nicotine replacement therapy (“NRT”).
These products consist of gums, patches, nasal sprays, inhalers and lozenges. Nicotine gums and nicotine patches have been sold
in the U.S. for approximately 32 years and 24 years, respectively, and millions of smokers have already tried NRT products and
failed to stop smoking due to the limited effectiveness of these products.
Research and Development
Since our inception, the majority of our
research and development (“R&D”) efforts have been outsourced to highly qualified groups in their respective fields.
Since 1998, we have had multiple R&D agreements with North Carolina State University (“NCSU”) resulting in exclusive
worldwide licenses to various patented technologies. We have utilized the same model employed by many public-sector research organizations,
which entails obtaining an exclusive option or license agreement to any invention arising out of funded research. In all cases,
we fund and control all patent filings as the exclusive licensee. This model of contracting with public-sector researchers has
enabled the Company to control R&D costs while achieving our desired results, including obtaining exclusive intellectual property
rights relating to our outsourced R&D.
Other R&D partners with the
same arrangement have included the National Research Council of Canada, Plant Biotechnology Institute in Saskatoon,
Canada (“NRC”), and the Nara Institute of Science and Technology in Nara, Japan (“NAIST”). The
majority of this R&D has involved the biosynthesis of nicotine in plants. Our R&D agreements with NCSU, NRC and NAIST
expired in 2009. In 2010, NAIST assigned to us all of its worldwide patents and patent applications that were previously
licensed to us on an exclusive basis. These patents and patent applications were a result of our R&D at NAIST. On
December 23, 2014, we purchased from NRC all the patents and patent applications that were previously licensed to us on an
exclusive basis by NRC.
In November 2011, we entered into
an R&D agreement with the University of Virginia (“UVA”) relating to nicotine biosynthesis in tobacco
plants with a total budget of $500,000 for the period from November 2011 through December 31, 2013. The term of the
R&D agreement with UVA was subsequently extended to May 31, 2016, with a total budget of $972,727. In 2016, the R&D
agreement with UVA was extended again through October 31, 2016. We incurred $224,560, $224,428 and $224,862 of expenses for
the R&D agreement at UVA for the years ended December 31, 2016, 2015, and 2014, respectively. In December 2016, we entered
into a new sponsored research agreement with UVA and an exclusive license agreement with the University of Virginia Patent
Foundation d/b/a University of Virginia Licensing & Ventures Group (“UVA LVG”) pursuant to which we will
invest approximately $1,000,000 over a three-year period with UVA to create unique industrial hemp plants with guaranteed
levels of THC below the legal limits and to optimize other desirable hemp plant characteristics to improve the plant’s
suitability for growing in Virginia and other legacy tobacco regions. This work with UVA will also involve the development
and study of medically important cannabinoids to be extracted by UVA from the Company’s unique hemp plants. UVA and
22nd Century will conduct all activities in this scientific collaboration within the parameters of state and federal licenses
and permits held by UVA for such work. The new agreeements with UVA and UVA LVG grant 22nd Century exclusive rights to
commercialize all results of the collaboration in consideration of royalty payments by the Company to UVA LVG.
We committed to an R&D
agreement with NCSU relating to nicotine biosynthesis in tobacco plants and incurred $162,408 in R&D expenses for the
period from February 2014 through January 2016. We extended the agreement through January 31, 2017 at an additional cost of
$85,681. During the year ended December 31, 2016, we expensed $78,541 relating to this extended R&D agreement. We plan to
extend and amend our R&D agreement with NCSU in 2017 to continue our research and development activities with NCSU
relating to very low nicotine tobacco plants. In this regard, NCSU has granted us a no-cost extension of our existing
sponsored research agreement so that we can finalize an amendment and extension of our R&D agreement with NCSU for our
continuing R&D activities together.
In August 2016, we opened our own laboratory
on the Buffalo Niagara Medical Campus in Buffalo, NY. We intend to conduct more of our proprietary research and development activities
in our laboratory when appropriate to do so.
We are currently working with Anandia Laboratories in Canada
to extend and expand our research and development activities with Anandia relating to industrial hemp and medical marijuana plants
with low-to-no amounts of THC.
Upon identifying a suitable joint venture
partner or licensee to fund further
X-22
clinical trials, we plan to carry out additional
X-22
clinical trials.
During the years ended December 31, 2016,
2015 and 2014, we incurred total R&D expenses of $2,340,958, $1,571,365, and $1,216,483, respectively.
Sources of Raw Materials
We obtain a large portion of our tobacco
leaf requirements from farmers in multiple U.S. states that are under direct contracts with us. The contracts prohibit the transfer
of our proprietary seedlings and plant materials to other parties. We purchase the balance of our tobacco requirements through
third parties. As we expand our sales and distribution of our current commercial brands and proceed to market with our
X-22
smoking cessation aid and
BRAND A
and
BRAND B
cigarettes, we plan to increase the amount of tobacco leaf we obtain
directly from farmers under contract, both in the United States and in foreign countries.
Products
RED SUN and MAGIC Cigarettes
Goodrich Tobacco introduced two super-premium
priced cigarette brands,
RED SUN
and
MAGIC
, into the U.S. market. Both brands are available in regular and menthol
and all brand styles are king size and packaged in hinge-lid hard packs. Since 2015, we have focused our marketing and sales efforts
for
RED SUN
on independent retailers, tobacconists, smokeshops and other tobacco outlets in the U.S. The ban in 2009 by
the FDA of all cigarettes with characterizing flavors (with the exception of menthol) has resulted in a product void in these tobacco
channels for highly differentiated, super-premium priced products. We believe that certain U.S. cigarette wholesalers and retailers
will carry our brands, among other reasons, to increase their margins.
RED SUN
is produced by our NASCO subsidiary at our
factory in North Carolina, which is now a subsequent participating manufacturer under the MSA, and
MAGIC
is produced for
us by Orion, our contract manufacturer in Poland, for distribution in the European Union.
SPECTRUM Government Research Cigarettes
NIDA, a part of NIH, provides
the scientific community with controlled and uncontrolled research chemicals and drug compounds in its Drug Supply Program.
In 2010, NIDA included an option to develop and produce research cigarettes with various levels of nicotine (from very low
to high), or Research Cigarette Option, in its request for proposals for a five-year contract for Preparation and
Distribution of Research and Drug Products. We agreed, as a subcontractor to RTI International (“RTI”) in
RTI’s contract with NIDA for the Research Cigarette Option, to supply cigarettes with different nicotine contents (from
very low to high) to NIDA. In August 2010, we met with officials from NIDA, FDA, RTI, the National Cancer Institute and the
Centers for Disease Control and Prevention to finalize certain aspects of the design of these research cigarettes. These
government research cigarettes produced by us under the mark
SPECTRUM
were distributed by RTI for NIDA to researchers.
The
SPECTRUM
research cigarette contract was renewed in 2015 for an additional 5 years. Goodrich Tobacco has thus far
delivered approximately 22 million
SPECTRUM
research cigarettes. On July 7, 2014, Goodrich Tobacco entered into a
Teaming Agreement with RTI to work together to respond to a new request from NIDA for the potential purchase by NIDA from RTI
of additional
SPECTRUM
research cigarettes to be produced and sold by Goodrich Tobacco to RTI. In 2015, NIDA ordered
approximately 5 million
SPECTRUM
research cigarettes and in 2016 NIDA ordered approximately 2.8 million
SPECTRUM
research cigarettes, all as made and sold by Goodrich Tobacco.
BRAND A and BRAND B
The Tobacco Control Act establishes procedures
for the FDA to regulate the labeling and marketing of cigarettes that (i) reduce exposure to tobacco toxins and (ii) are reasonably
likely to pose lower health risks as compared to conventional cigarettes (“Modified Risk Cigarettes”). The Tobacco
Control Act requires the FDA to issue specific regulations and guidance regarding applications submitted to the FDA for the authorization
to label and market modified risk tobacco products, including Modified Risk Cigarettes. On March 30, 2012, the FDA issued
Modified
Risk Tobacco Product Applications Draft Guidance.
We believe that two types of our cigarettes in development, which we refer
to as
BRAND A
and
BRAND B
, may qualify as Modified Risk Cigarettes. In addition, the Tobacco Control Act
allows the FDA to mandate the use of reduced risk technologies in conventional tobacco products and cigarettes (e.g., Marlboro
®
, Camel
®
, Newport
®
, Natural American Spirit
®
), which could create opportunities
for us to license our proprietary technology and/or our tobaccos to larger competitors.
Compared to commercial tobacco
cigarettes,
BRAND A
has the lowest nicotine content. The tobacco in
BRAND A
contains approximately 95% less
nicotine than conventional cigarette brands. As mentioned above, we are working to receive a marketing order from the FDA to
allow
BRAND A
to be marketed as a reduced exposure product.
Utilizing the results of previously
conducted independent clinical trials (see below under “X-22 Smoking Cessation Aid”), on December 31, 2015, we
submitted to the Center for Tobacco Products (“CTP”) of the FDA a combined Modified Risk Tobacco Product
Application (“MRTPA”) and a Premarket Tobacco Product Application (“PMTA”) for
BRAND A
as a
Modified Risk Cigarette. In December 2016, we received feedback and guidance from the FDA on our MRTPA and PMTA for
BRAND
A
, which resulted in us withdrawing that filing in order to (i) include additional information requested by the FDA and
(ii) bifurcate our application into a separate MRTPA to be filed with the FDA for
BRAND A
and a separate PMTA to be
filed with the FDA for
BRAND A
in order to benefit from the FDA’s shorter review timing for PMTAs as compared
to MRTPAs.
Using a proprietary high nicotine tobacco
blend in conjunction with specialty cigarette components,
BRAND B
allows the smoker to achieve a satisfactory amount of
nicotine per cigarette while inhaling less “tar” and carbon monoxide. At the same time, we do not expect exposure
to nicotine from
BRAND B
to be significantly higher than some commercially available full flavor cigarette brands. We submitted
an application with the FDA for the Company’s first proposed smoke evaluation exposure study for our
BRAND B
cigarettes.
This first proof of concept study for
BRAND B
is scheduled for the second quarter of 2017, subject to completion of FDA review.
We believe results from this and
other exposure studies will warrant a modified risk claim for
BRAND B
and we believe smokers who desire to reduce
smoke exposure, but are less concerned about nicotine, will find
BRAND B
beneficial. Although smoking yields, as
determined by laboratory smoking machines, are not always indicative of smoke and tar intake by humans,
BRAND B
cigarettes
are being designed to have a “tar” yield between typical “light” and “ultra-light”
cigarettes (as previously labeled and marketed by conventional tobacco companies), but a nicotine yield of typical full flavor
cigarettes.
X-22 Smoking Cessation Aid
X-22
is a tobacco-based
botanical medical product for use as an aid to smoking cessation. The
X-22
therapy protocol utilized in our sponsored
Phase IIb clinical trial calls for the patient to switch to our
X-22
cigarettes over a six-week treatment period to
facilitate the goal of the patient quitting smoking following the treatment period. We believe this therapy protocol has been
successful in independent clinical trials because cigarettes made from our proprietary tobacco satisfy smokers’
cravings for cigarettes while (i) greatly reducing nicotine exposure and nicotine dependence and (ii) extinguishing the
association between the act of smoking and the rapid delivery of nicotine.
X-22
involves the same smoking behavior as
conventional cigarettes and because patients are simply switching to
X-22
cigarettes for 6 weeks,
X-22
does not
expose the smoker to any new drugs or new side effects. Our Investigational New Drug Application (“IND”) for
X-22
was cleared by the FDA in July 2011 and has been updated annually. Our
X-22
Phase IIb clinical trial was completed in
the first quarter of 2012 but did not demonstrate a statistically significant difference in quitting between
X-22
and
the active control, a cigarette containing conventional nicotine levels. However, the median number of
X-22
cigarettes
smoked during the trial was significantly reduced compared to patients’ baseline of usual brand of cigarettes. In
evaluating the results of this trial, we believe we may have reduced the nicotine content of
X-22
by too great a
percentage, to a level less than half the nicotine content of our VLN cigarettes used in various independent
smoking-cessation clinical trials that have demonstrated that use of VLN cigarettes increases quit rates. In preparation for
Phase III clinical trials, the Company has requested and has been granted a meeting with the FDA to discuss
X-22
. At
the meeting, which is scheduled to take place in June 2017, 22nd Century will discuss a product development program for
X-22
that is expected to outline a path for the Company’s one-of-a-kind combustible smoking cessation aid to become a
prescription-based treatment option for smokers in the United States.
Due to the limited
effectiveness and/or serious side effects of existing FDA-approved smoking cessation products (all of which have been on the
market for approximately between 10 and 32 years), we believe that if additional clinical trials demonstrate increased
smoking cessation rates, then
X-22
can capture a share of this market by replacing sales and market share from
existing smoking cessation aids and by expanding the smoking cessation market by encouraging more smokers to attempt to quit
smoking. In contrast to the results of our Phase IIb trial results, the independent studies listed below have demonstrated
that cigarettes with very
low nicotine
content
increase quit rates, whether used alone, in conjunction with Chantix
®
(varenicline) or in
conjunction with nicotine replacement therapy (“NRT”) such as nicotine patches, gums or lozenges. The
independent clinical studies listed below are indeed remarkable for their results and/or the conclusions reached by the
researchers, but were not conducted or monitored by us and are included herein for informational purposes only. We assume no
obligation to review any of these independent studies for errors, omissions or other factors.
|
·
|
Donny, EC et al. Randomized
trial of reduced-nicotine standards for cigarettes. 2015.
New Eng. J. Med,
2015; 373;14:1340-1349.
|
|
·
|
Phase II/III clinical trial
|
|
·
|
McRobbie, H et al. Evaluating
whether the use of a VLN cigarette in combination with Chantix® (or NRT) increases quitting over use of Chantix (or NRT) alone.
2015.
Nicotine & Tobacco Research, June 2015; doi:10.1093/ntr/ntv122
|
|
·
|
Phase II clinical trial
|
|
·
|
Reduced nicotine content
cigarettes and nicotine patch. Hatsukami DK, Hertsgaard LA, Vogel RI, Jensen JA, Murphy SE, Hecht SS, Carmella SG, al'Absi M,
Joseph AM, Allen SS. 2013. Reduced nicotine content cigarettes and nicotine patch.
Cancer Epidemiol Biomarkers Prev
. 22(6):1015-24.
|
|
·
|
Phase II clinical trial
|
|
·
|
Hatsukami DK, Kotlyar M,
Hertsgaard LA, Zhang Y, Carmella SG, Jensen J, Allen SS, Shields PG, MurphySE, Stepanov I, Hecht SS. 2010. Reduced nicotine content
cigarettes: effects on toxicant exposure, dependence and cessation.
Addiction
105:343-355.
|
|
·
|
Phase II clinical trial
|
|
·
|
Walker N, Howe C, Bullen
C, Grigg M, Glover M, McRobbie H, Laugesen M, Parag V, Whittaker R. 2012. The combined effect of very low nicotine content cigarettes,
used as an adjunct to usual Quitline care (nicotine replacement therapy and behavioural support), on smoking cessation: a randomized
controlled trial.
Addiction
. 2012 Oct; 107(10):1857-67.
|
|
·
|
Phase III/IV clinical trial
|
|
·
|
Becker KM, Rose JE, Albino
AP. 2008. A randomized trial of nicotine replacement therapy in combination with reduced-nicotine cigarettes for smoking cessation.
Nicotine Tob Res
10(7):1139-48.
|
|
·
|
Phase II clinical trial
|
|
·
|
Rezaishiraz H, Hyland A,
Mahoney MC, O’Connor RJ, Cummings KM. 2007. Treating smokers before the quit date: can nicotine patches and denicotinized
cigarettes reduce cravings?
Nicotine Tob Res
. Nov; 9(11):1139-46.
|
|
·
|
Phase II clinical trial
|
FDA approval must be obtained, as has been
the case for decades, before a product can be marketed for quitting smoking. The Tobacco Control Act provides that products for
quitting smoking or smoking cessation, such as
X-22
, be considered for “Fast Track” designation by the FDA.
The “Fast Track” programs of the FDA are intended to facilitate development and to expedite review of drugs to treat
serious and life-threatening conditions so that an approved product can reach the market expeditiously. We believe that upon completion
of a Company-sponsored clinical trial demonstrating efficacy,
X-22
will qualify for “Fast Track” designation
by the FDA.
We believe that our
X-22
cigarettes can be a highly effective aid to smoking cessation. We are currently in the process of identifying potential
joint venture partners or licensees to fund the remaining
X-22
clinical trials. In preparation for Phase III
clinical trials, the Company has requested and has been granted a June 2017 meeting with the Center for Drug Evaluation and
Research (“CDER”) of the FDA to discuss a development program for
X-22
.
Government Regulation
Smoking Cessation Aids
Government authorities in the U.S. and
foreign countries extensively regulate the research, development, testing, manufacture, labeling, promotion, advertising, distribution,
sampling, marketing and import and export of pharmaceutical products. FDA approval must be obtained, as has been the case for decades,
before a product can be marketed for quitting smoking or reducing withdrawal symptoms. In addition, as with all FDA-approved prescription
drugs, the FDA must approve the brand name of our
X-22
smoking cessation aid. The FDA approval process for smoking cessation
aids is similar to that required by the FDA for new drug approvals, although the cost to complete clinical trials for a smoking
cessation aid such as
X-22
are generally far less than clinical trials for drugs. The primary endpoint of the clinical trial
for smoking cessation aids is smoking abstinence, which is generally confirmed by inexpensive, noninvasive biomarker tests. Since
potential quitters are already smokers,
X-22
will not expose participants in the clinical trials to any new compounds, unlike
a new chemical product, such as Chantix
®
.
The process of obtaining governmental approvals
and complying with ongoing regulatory requirements requires the expenditure of substantial time and financial resources. In addition,
statutes, rules, regulations and policies may change and new legislation or regulations may be issued that could delay such approvals.
If we fail to comply with applicable regulatory requirements at any time during the product development process, approval process,
or after approval, we may become subject to administrative or judicial sanctions. These sanctions could include the FDA’s
refusal to approve pending applications, withdrawals of approvals, clinical holds, warning letters, product recalls, product seizures,
total or partial suspension of our operations, injunctions, fines, civil penalties or criminal prosecution. Any agency enforcement
action could have a material adverse effect on us.
The Affordable Care Act and other government
and private sector initiatives targeted to potentially limit the growth of healthcare costs are continuing in the U.S. and many
other countries where we intend to sell our products, including our
X-22
smoking cessation aid. These changes are causing
the marketplace to put increased emphasis on the delivery of more cost-effective medical products.
Government healthcare programs in the United
States, including Medicare and Medicaid, private healthcare insurance and managed-care plans have attempted to control costs by
limiting the amount of reimbursement for which they will pay for particular procedures or treatments. This may create price sensitivity
among potential customers for our
X-22
smoking cessation aid, even if we obtain FDA approval for it. Some third-party payers
must also approve coverage for new or innovative devices or therapies before they will reimburse healthcare providers who use the
medical devices or therapies. Even though a new medical product may have been cleared for commercial distribution, we may find
limited demand for
X-22
until reimbursement approval has been obtained from governmental and private third-party payers.
Modified Risk Cigarettes
The Tobacco Control Act, which became law
in June 2009, prohibits the FDA from banning cigarettes outright or mandating that nicotine levels be reduced to zero. However,
among other things, it allows the FDA to require the reduction of nicotine or any other compound in cigarettes. In 2009, the Tobacco
Control Act banned all sales in the United States of cigarettes with flavored tobacco (other than menthol). As of June 2010, all
cigarette companies were required to cease using the terms “low tar,” “light” and “ultra-light”
in describing cigarettes sold in the United States. We believe this new regulatory environment represents a paradigm shift for
the tobacco industry and will create opportunities for us in marketing
BRAND A
and
BRAND B
and in licensing our proprietary
technology and/or tobaccos to larger competitors.
For the first time in history, a U.S. regulatory
agency now scientifically evaluates cigarettes that may pose lower health risks as compared to conventional cigarettes. The Tobacco
Control Act established procedures for the FDA to regulate the labeling and marketing of modified risk tobacco products, which
includes cigarettes that (i) reduce exposure to tobacco smoke toxins and/or (ii) pose lower health risks, as compared to conventional
cigarettes (“Modified Risk Cigarettes”). The Tobacco Control Act requires the FDA to issue specific regulations and
guidance regarding applications that must be submitted to the FDA for the authorization to label and market Modified Risk Cigarettes.
We believe that
BRAND A
and
BRAND B
will qualify as Modified Risk Cigarettes. In addition, the Tobacco Control Act
allows the FDA to mandate the use of reduced risk technologies in conventional tobacco products and cigarettes (e.g., Marlboro
®
, Camel
®
, Newport
®
, Natural American Spirit
®
) which could create opportunities
for us to license our proprietary technology and/or our tobaccos to larger competitors.
In addition to providing our
SPECTRUM
cigarettes to NIDA for researchers, we have been directly supplying our proprietary cigarettes to independent researchers so that
additional studies can be conducted to obtain additional information on our products. We expect this information will assist us,
along with our own funded studies, in obtaining the necessary FDA authorizations to market
BRAND A
and
BRAND B
as
Modified Risk Cigarettes and to obtain FDA approval for
X-22
as a prescription smoking cessation aid.
Competition
In the market for FDA-approved smoking
cessation aids, our principal competitors include Pfizer Inc., GlaxoSmithKline plc, Novartis International AG, and Perrigo Company
plc. The industry consists of major domestic and international companies, most of which have existing relationships in the markets
into which we plan to sell, as well as financial, technical, marketing, sales, manufacturing, scaling capacity, distribution and
other resources, and name recognition substantially greater than ours.
Cigarette companies compete primarily on
the basis of product quality, brand recognition, brand loyalty, taste, innovation, packaging, service, marketing, advertising,
retail shelf space and price. Cigarette sales can be significantly influenced by weak economic conditions, erosion of consumer
confidence, competitors’ introduction of low-price products or innovative products, higher cigarette taxes, higher absolute
prices and larger gaps between price categories, and product regulation that diminishes the ability to differentiate tobacco products.
Domestic competitors include Philip Morris USA, Reynolds American Inc., ITG Brands, Liggett Group LLC and Vector Tobacco Inc. International
competitors include Philip Morris International Inc., Japan Tobacco Inc., Imperial Tobacco Group plc, and regional and local tobacco
companies.
Biomass Products
Biomass products are products such as
ethanol made from organic material, which is derived from plants densely grown over a given area. We have funded extensive
biomass field trials conducted by NCSU and work on feedstock digestibility and bioconversion at the National Renewable
Energy Lab. Bioconversion is the conversion of organic matter into a source of energy, such as ethanol in our own research,
through the action of microorganisms. Tobacco has a number of advantages as a starting point for development of novel
bioproduct crop systems. Because tobacco is a widely cultivated crop, grown in over 100 countries throughout the world,
tobacco agronomy is highly understood. For decades, tobacco has been used as a model system for plant biology, and recently
the tobacco genome has been mapped. Tobacco plants rapidly sprout back after each harvest and produce large amounts of leaf
and total biomass. Tobacco grown for cigarettes yields about 3,000 pounds of cured leaf per acre (~20% moisture) per year
from 7,500 tobacco plants. In our field trials in North Carolina, nicotine-free tobacco grown for biomass yields about
100,000 pounds of fresh weight per acre (which equals 10,000 pounds of dry weight) per year with multiple machine harvests
from about 80,000 tobacco plants. The results of our biomass studies have been summarized in a comprehensive feasibility
study relating to our nicotine-free tobacco biomass crop (
Verfola
) to produce a variety of bioproducts. First, protein
and other plant fractions are extracted, and then biofuels and other products are produced from the remaining cellulosic
residue.
In 2009, we put our biomass
development projects on hold so that our management could focus its attention and resources on our modified risk cigarette
business and our
X-22
smoking cessation business. We do not plan to move forward with potential biomass business
activities until some period of time after FDA approval of
X-22
or FDA authorization to market
BRAND A
or
BRAND
B
as a Modified Risk Cigarette. We currently are not spending any capital for such potential biomass business activities
nor do we have any current plans to do so in the foreseeable future.
Cannabis Research
We currently sponsor
cannabis research in Canada and in the United States. In Canada, we conduct sponsored research on cannabis through Botanical
Genetics, which is a wholly-owned subsidiary of the Company and was incorporated to facilitate an equity investment in
Anandia Laboratories, Inc. (“Anandia”), a plant biotechnology company based in Vancouver, Canada. On September
15, 2014, Botanical Genetics was granted a sublicense by Anandia to 23 patent applications relating to genes in the
cannabis plant that are required for the production of cannabinoids, the active ingredients in the cannabis plant, with such
sublicense being exclusive in the United States and co-exclusive with Anandia everywhere else in the world, except Canada
where Anandia has retained exclusive rights. The Anandia sublicense continues through the life of the last-to-expire patent,
which is expected to be in 2035. Under licenses granted by the Canadian government to Anandia, we conduct research and
development on unique plant varieties of hemp/cannabis, such as (i) plants with low to no amounts of
delta-9-tetrahydrocannabinol, or THC, for the legal hemp industry, and (ii) plants with high levels of cannabidiol, or CBD,
and other non-THC cannabinoids for the legal medical cannabis markets. In Canada, licenses to cultivate, possess and supply
cannabis for medical research are granted by agencies of the Canadian federal government. In order to carry out research in
other countries, similar licenses are required to be issued by the relevant authority in each country.
In the United States, we
conduct sponsored research on hemp at the University of Virginia (“UVA”). In December 2016, we entered into a
sponsored research agreement with UVA and an exclusive license agreement with the University of Virginia Patent Foundation
d/b/a University of Virginia Licensing & Ventures Group (“UVA LVG”). Over the next three years, we will
invest approximately $1,000,000 in this scientific collaboration. The goals of the research agreement include: (i) creating
unique industrial hemp plants with guaranteed levels of THC below the legal limits (thus eliminating the risk to growers of
having to destroy non-conforming hemp crops) and (ii) optimizing other desirable hemp plant characteristics to improve
the plant’s suitability for growing in Virginia and in similar legacy tobacco regions. The collaboration with UVA will
also involve the development and study of medically important cannabinoids to be extracted by UVA from the Company’s
unique hemp plants. UVA and 22nd Century will conduct all activities in this scientific collaboration within the parameters
of state and federal licenses and permits held by UVA for such work. The agreements with UVA and UVA LVG grant 22nd Century
exclusive rights to commercialize all results of the collaboration in consideration of royalty payments by the Company to UVA
LVG.
As of December 31, 2016, there are
29 states in the United States plus the District of Columbia that have laws and/or regulations that recognize, in one form
or another, legitimate medical uses for cannabis and consumer use of cannabis in connection with medical
treatment. Additionally, the states of Alaska, California, Colorado, Maine, Massachusetts, Nevada, Oregon, Washington plus
the District of Columbia have legalized cannabis for adult use. Many other states are considering similar legislation.
Conversely, under the federal Controlled Substance Act (the “CSA”), the policies and regulations of the federal
government and its agencies are that cannabis has no medical benefit and a range of activities are prohibited, including
cultivation, possession, personal use and interstate distribution of cannabis. In the event the U.S. Department of Justice
(the “DOJ”) begins strict enforcement of the CSA in states that have laws legalizing medical marijuana
and recreational marijuana in small amounts, there may be a direct and adverse impact to any future business or prospects
that we have in the cannabis business. However, our work in hemp would continue since hemp R&D and commercialization
activities are permitted under applicable federal and state laws, rules and regulations.
Employees
We currently
employ forty-six (46) people and we consider our employee relations to be good.
Corporate Information
We are a Nevada corporation and our corporate
headquarters is located at 9530 Main Street, Clarence, New York 14031. Our telephone number is (716) 270-1523. Our internet address
is www.xxiicentury.com. We do not incorporate the information on our website into this Annual Report on Form 10-K.
You should carefully consider the risk
factors set forth below and in other reports that we file from time to time with the Securities and Exchange Commission and the
other information in this Annual Report on Form 10-K. The matters discussed in the risk factors, and additional risks and uncertainties
not currently known to us or that we currently deem immaterial, could have a material adverse effect on our business, financial
condition, results of operation and future growth prospects and could cause the trading price of our common stock to decline.
Risks Related to Our Business and Operations
We have had a history of losses, and we may be unable
to (i) achieve and sustain profitability or (ii) raise additional capital on favorable terms; or at all.
We have experienced net losses of
approximately $11.6 million, $11.0 million, and $15.6 million during the years ended December 31, 2016,
2015 and 2014, respectively. At December 31, 2016, we had current assets of $16,797,435, current liabilities of
$3,249,317, and cash on hand of $13,468,188. Excluding discretionary expenses related to R&D, patent and trademark costs, contract growing of
our proprietary tobacco, and certain nonrecurring expenses relating to factory capital expenses, investor relations, and
marketing costs, our monthly cash
expenditures are approximately $750,000. Including cash on hand at December 31, 2016 of $13,468,188, and revenues
from ongoing product sales, but not including potential milestone payments of up to $7,000,000 from BAT, we believe resulting
cash balances will be adequate to sustain operations and meet all current obligations as they come due through at
least May of 2018. While our current cash balance is adequate to sustain operations through at
least May of
2018, generating net income in the future will depend on our ability to successfully operate our cigarette manufacturing
facility, sell and market our proprietary tobacco products and generate additional royalty revenue from the licensing our
intellectual property. There is no guarantee that we will be able to achieve or sustain profitability in the future. An
inability to successfully achieve profitability may decrease our long-term viability. There is also no guarantee that we will
be able to raise additional capital on favorable terms, or at all. Any inability to raise additional capital could have an
impact on our ability to continue to operate our business.
We have had a history of negative cash flow, and our ability
to sustain positive cash flow is uncertain.
We have had a history of negative
cash flow from operating activities, before cash used in investing activities and cash from financing activities, including
approximately $9.9 million during the year ended December 31, 2016. As indicated above, we believe our current cash position
is adequate to sustain operations and meet all current obligations as they come due through at
least May of 2018.
Generation of positive cash flow from operations will depend on our ability to successfully implement the net income
generating activities discussed in the previous risk factor discussion. An inability to successfully implement our net income
producing initiatives may decrease our long-term viability.
Our working capital requirements involve estimates based
on demand expectations and may increase beyond those currently anticipated, which could harm our operating results and financial
condition.
We have no experience in selling Modified
Risk Cigarettes or smoking cessation products on a commercial basis. As a result, we intend to base our funding and inventory decisions
on estimates of future demand. If demand for our products does not increase as quickly as we have estimated, our inventory and
expenses could rise, and our business and operating results could suffer. Alternatively, if we experience sales in excess of our
estimates, our working capital needs may be higher than those currently anticipated. Our ability to meet any demand for our products
may depend on our ability to arrange for additional financing for any ongoing working capital shortages, since it is likely that
cash flow from sales will lag behind our investment requirements.
We will likely require additional capital before we can
complete the FDA authorization process for our X-22 smoking cessation aid and our Modified Risk Cigarettes.
We are currently seeking a suitable joint
venture partner or licensee willing to fund further clinical trials for FDA approval of our
X-22
smoking cessation aid.
At that time we will resume our own sponsored
X-22
clinical trials. There is no guarantee that we will identify a joint
venture partner or licensee willing to fund further
X-22
clinical trials on terms that are acceptable to us. We estimate
the cost of completing two Phase III trials to be approximately $25 million. We will also likely require additional capital in
the future before we can complete the FDA authorization process for our Modified Risk Cigarettes. The cost of completing the FDA
authorization process for each of our two potential Modified Risk Cigarettes is difficult to estimate since it is currently unknown
exactly what the FDA will require, including the number and size of exposure studies. If we raise additional funds through the
issuance of equity securities to complete the FDA authorization process for our Modified Risk Cigarettes, our stockholders may
experience substantial dilution, or the equity securities may have rights, preferences or privileges senior to those of existing
stockholders. If we raise additional funds through debt financings, these financings may involve significant cash payment obligations
and covenants that restrict our ability to operate our business and make distributions to our stockholders. We could also wait
for our own revenues and profits to be sufficient for us to provide such funding, which could delay our completion of the FDA authorization
process for our Modified Risk Cigarettes. We also could elect to seek funds through arrangements with collaborators or licensees.
To the extent that we raise additional funds through collaboration and licensing arrangements, it may be necessary to relinquish
some rights to our technologies or our potential products or grant licenses on terms that are not favorable to us.
If we choose to resume and fund our
own clinical trials for FDA approval of our
X-22
smoking cessation aid and we cannot raise additional capital on
acceptable terms, we may not be able to, among other things:
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complete clinical trials
of our
X-22
smoking cessation aid;
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undertake the steps necessary
to seek FDA authorization of our Modified Risk Cigarettes;
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develop or enhance our
potential products or introduce new products;
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expand our development,
sales and marketing and general and administrative activities;
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attract tobacco growers,
customers or manufacturing and distribution partners
;
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acquire complementary
technologies, products or businesses;
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expand our operations
in the United States or internationally;
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hire, train and retain
employees; or
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respond to competitive
pressures or unanticipated working capital requirements.
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We face intense competition in the market for our cigarettes and our failure to compete effectively or to achieve market acceptance
of these products could have a material adverse effect on our profitability and results of operations.
Cigarette companies compete primarily
on the basis of product quality, brand recognition, brand loyalty, taste, innovation, packaging, service, marketing,
advertising, retail shelf space and price. We are subject to highly competitive conditions in all aspects of our business and
we may not be able to effectively market, sell and achieve market acceptance for our
proprietary cigarettes. The
competitive environment and our competitive position can be significantly influenced by weak economic conditions, erosion of
consumer confidence, competitors’ introduction of low-price products or innovative products, higher cigarette taxes,
higher absolute prices and larger gaps between price categories, and product regulation that diminishes the ability to
differentiate tobacco products. In addition, most of our competitors have greater resources and brand recognition than
us. Domestic competitors include Philip Morris USA Inc., Reynolds American Inc., ITG Brands, Liggett Group LLC, and Vector
Tobacco Inc. International competitors include Philip Morris International Inc., Japan Tobacco, Inc., Imperial Tobacco Group
plc and regional and local tobacco companies.
We will mainly depend on third parties to market, sell
and distribute our products, and we currently have no commercial arrangements for the marketing, sale or distribution of our X-22
smoking cessation aid.
We expect to depend on third parties to
a great extent to market, sell and distribute our products and we currently have no arrangements with third parties in place to
provide such services for our
X-22
smoking cessation aid. We cannot be sure that we will be able to enter into such arrangements
on acceptable terms, or at all. If we are unable to enter into marketing, sales and distribution arrangements with third parties
for our
X-22
smoking cessation aid, we would need to incur significant sales, marketing and distribution expenses in connection
with the commercialization of
X-22
and any future potential products. We do not currently have a dedicated sales force,
and we have no experience in the sales, marketing and distribution of pharmaceutical products. Developing a sales force is expensive
and time-consuming, and we may not be able to develop this capacity. If we are unable to establish adequate sales, marketing and
distribution capabilities, independently or with others, we may not be able to generate significant revenue and may not become
profitable.
We have no experience in managing growth. If we fail to
manage our growth effectively, we may be unable to execute our business plan or address competitive challenges adequately.
From 2013 to 2016 we grew from nine
(9) employees to forty-six (46) employees. Any growth in our business will place a significant strain on our
managerial, administrative, operational, financial, information technology and other resources. We intend to further expand
our overall business, customer base, employees and operations, which will require substantial management effort and
significant additional investment in our infrastructure. We will be required to continue to improve our operational,
financial and management controls and our reporting procedures and we may not be able to do so effectively. As such, we may
be unable to manage our growth effectively.
We have limited experience in operating and managing a
manufacturing facility.
We have limited experience operating and
managing a manufacturing facility. The manufacture of products is subject to strict quality control, testing and record keeping
requirements, and continuing obligations regarding the submission of safety reports and other post-market information. In addition,
the manufacturing of our own products will be expensive to operate without sufficient production volume. If we are unable to successfully
manufacture or sell our products, we will still be liable for the costs associated with operating a manufacturing facility. Accordingly,
the operation of such manufacturing facility could have a material adverse effect on our results of operations.
Our manufacturing facility is subject to FDA regulations.
Manufacturers of tobacco and pharmaceutical
products must comply with FDA regulations which require, among other things, compliance with the FDA’s evolving regulations
on Current Good Manufacturing Practices (“cGMP(s)”), which are enforced by the FDA through its facilities inspection
program. The manufacture of products is subject to strict quality control, testing and record keeping requirements, and continuing
obligations regarding the submission of safety reports and other post-market information. We cannot guarantee that our current
manufacturing facility will pass FDA and/or similar inspections in foreign countries to produce our tobacco products or the final
version of our
X-22
smoking cessation aid, or that future changes to cGMP manufacturing standards will not also negatively
affect the cost or sustainability of our manufacturing facility.
If our X-22 smoking cessation aid does not gain market
acceptance among physicians, patients, third-party payers and the medical community, we may be unable to generate significant revenue.
Our
X-22
smoking cessation aid may
not achieve market acceptance among physicians, patients, third-party payers and others in the medical community. If we receive
FDA approval for the marketing of
X-22
as a smoking cessation aid in the U.S., the degree of market acceptance could depend
upon a number of factors, including:
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limitations on the indications
for use for which
X-22
may be marketed;
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the establishment and
demonstration in the medical community of the clinical efficacy and safety of our potential products and their potential advantages
over existing products;
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the prevalence and severity
of any side effects;
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the strength of marketing
and distribution support; and
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sufficient third-party
coverage or reimbursement.
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The market may not accept our
X-22
smoking cessation aid, based on any number of the above factors. Even if the FDA approves the marketing of
X-22
as a smoking
cessation aid, there are other FDA-approved products available and there will also be future competitive products which directly
compete with
X-22
. The market may prefer such existing or future competitive products for any number of reasons, including
familiarity with or pricing of such products. The failure of any of our potential products to gain market acceptance could impair
our ability to generate revenue, which could have a material adverse effect on our future business, financial condition, results
of operations and cash flows.
Our principal competitors in the smoking cessation market
have, and any future competitors may have, greater financial and marketing resources than we do, and they may therefore develop
products or other technologies similar or superior to ours or otherwise compete more successfully than we do.
We have no experience in selling smoking
cessation products. Competition in the smoking cessation aid products industry is intense, and we may not be able to successfully
compete in the market. In the market for FDA-approved smoking cessation aids, our principal competitors include Pfizer Inc., GlaxoSmithKline
plc, Perrigo Company plc and Novartis International AG. The industry consists of major domestic and international companies, most
of which have existing relationships in the markets which we plan to sell, as well as financial, technical, marketing, sales, manufacturing,
scaling capacity, distribution and other resources and name recognition substantially greater than ours. In addition, we expect
new competitors will enter the markets for our products in the future. Potential customers may choose to do business with our more
established competitors, because of their perception that our competitors are more stable, are more likely to complete various
projects, can scale operations more quickly, have greater manufacturing capacity, are more likely to continue as a going concern
and lend greater credibility to any joint venture. If we are unable to compete successfully against manufacturers of other smoking
cessation products, our business could suffer, and we could lose or be unable to obtain market share.
Our competitors may develop products that are less expensive,
safer or otherwise more appealing, which may diminish or eliminate the commercial success of any potential product that we may
commercialize.
If our competitors market products that
are less expensive, safer or otherwise more appealing than our potential products, or that reach the market before our potential
products, we may not achieve commercial success. The market may choose to continue utilizing existing products for any number of
reasons, including familiarity with or pricing of these existing products. The failure of our
X
-22 smoking cessation aid
or our cigarette brands to compete with products marketed by our competitors would impair our ability to generate revenue, which
would have a material adverse effect on our future business, financial condition, results of operations and cash flows. Our competitors
may:
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develop and market products
that are less expensive, safer or otherwise more appealing than our products;
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commercialize competing
products before we or our partners can launch our products; and
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initiate or withstand
substantial price competition more successfully than we can.
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If we fail to stay at the forefront of technological change,
we may be unable to compete effectively.
Our competitors may render our technologies
obsolete by advances in existing technological approaches or the development of new or different approaches, potentially eliminating
the advantages that we believe we derive from our research approach and proprietary technologies. Our competitors may:
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operate larger research
and development programs or have substantially greater financial resources than we do;
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have greater success
in recruiting skilled technical and scientific workers from the limited pool of available talent;
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more effectively negotiate
third-party licenses and strategic relationships; and
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take advantage of acquisition
or other opportunities more readily than we can.
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Government mandated prices, production control programs,
shifts in crops driven by economic conditions and adverse weather patterns may increase the cost or reduce the quality of the tobacco
and other agricultural products used to manufacture our products.
We depend on independent tobacco farmers
to grow our specialty proprietary tobaccos with specific nicotine contents for our products. As with other agricultural commodities,
the price of tobacco leaf can be influenced by imbalances in supply and demand, and crop quality can be influenced by variations
in weather patterns, diseases and pests. We must also compete with other tobacco companies for contract production with independent
tobacco farmers. Tobacco production in certain countries is subject to a variety of controls, including government mandated prices
and production control programs. Changes in the patterns of demand for agricultural products could cause farmers to plant less
tobacco. Any significant change in tobacco leaf prices, quality and quantity could affect our profitability and our business.
Our future success depends on our ability to retain key
personnel.
Our success will depend to a significant
extent on the continued services of our senior management team, and in particular Henry Sicignano III, our President and Chief
Executive Officer, John T. Brodfuehrer, our Chief Financial Officer, Dr. Paul Rushton, our Vice President of Plant Biotechnology,
and Thomas James, Esq., our Vice President, General Counsel and Secretary. The loss or unavailability of any of these individuals
may significantly delay or prevent the development of our potential products and other business objectives by diverting management’s
attention to transition matters. While each of these individuals is party to employment agreements with us, they could terminate
their relationships with us at any time, and we may be unable to enforce any applicable employment or non-compete agreements.
We also rely on consultants and advisors
to assist us in formulating our research and development, manufacturing, distribution, marketing and sales strategies. All of our
consultants and advisors are either self-employed or employed by other organizations, and they may have conflicts of interest or
other commitments, such as consulting or advisory contracts with other organizations, that may affect their ability to contribute
to us.
Product liability claims, product recalls or other claims
could cause us to incur losses or damage our reputation.
The risk of product liability claims or
product recalls, and associated adverse publicity, is inherent in the development, manufacturing, marketing and sale of tobacco
and smoking cessation products. We do not currently have product liability insurance for our products or our potential products
and do not expect to be able to obtain product liability insurance at reasonable commercial rates for these products. Any product
recall or lawsuit seeking significant monetary damages may have a material adverse effect on our business and financial condition.
A successful product liability claim against us could require us to pay a substantial monetary award. We cannot assure you that
such claims will not be made in the future.
Negative press from entering the cannabis space could
have a material adverse effect on our business, financial condition and results of operations.
Despite growing support for the cannabis
industry and legalization of cannabis in certain U.S. states, many individuals and businesses remain opposed to the cannabis industry.
Any negative press resulting from our recent entry into the cannabis space could result in a loss of current or future business.
It could also adversely affect the public’s perception of us and lead to reluctance by new parties to do business with us
or to own our common stock. We cannot assure you that additional business partners, including but not limited to financial institutions
and customers, will not attempt to end or curtail their relationships with us. Any such negative press or cessation of business
could have a material adverse effect on our business, financial condition and results of operations.
Any business related cannabinoid production is dependent
on laws pertaining to the cannabis industry
.
As of December 31, 2016, 29 states and
the District of Columbia allow their citizens to use medical marijuana. Additionally, the states of Alaska, California, Colorado,
Maine, Massachusetts, Nevada, Oregon, Washington plus the District of Columbia have legalized cannabis for adult use. The state
laws are in conflict with the federal Controlled Substances Act, or CSA, which makes marijuana use, possession and interstate distribution
illegal on a federal level.
We currently conduct
sponsored research on cannabis through Anandia Laboratories in Canada and sponsored research on hemp in Virginia through
the University of Virginia (“UVA”), in each case with Anandia and UVA possessing all necessary permits and
licenses to engage in such activities. In order to carry out research in other countries, similar licenses are required to be
issued by the relevant authority in each country.
Local, state, federal and
international medical cannabis laws and regulations are broad in scope and subject to evolving interpretations, which could
require us to incur substantial costs associated with compliance requirements. In addition, violations of these laws, or
allegations of such violations, could disrupt our business and result in a material adverse effect on our operations. In
addition, it is possible that regulations may be enacted in the future that will be directly applicable to our proposed
business regarding cannabinoid production. It is also possible that the federal government will begin strictly enforcing
existing laws, which would effectively terminate our cannabis research in the United States. However, our work in hemp would
continue since hemp R&D and commercialization activities are permitted under applicable federal and state laws, rules and
regulations. We cannot predict the nature of any future laws, regulations, interpretations or applications, nor can
we determine what effect additional governmental regulations or administrative policies and procedures, when and if
promulgated, could have on our proposed business.
Risks Related to Regulatory Approvals and Insurance Reimbursement
If we fail to obtain FDA and foreign regulatory approvals
for X-22 as a smoking cessation aid and FDA authorization to market BRAND A and BRAND B as Modified Risk Cigarettes, we will be
unable to commercialize these potential products in and outside the U.S., other than the sale of our BRAND A and BRAND B cigarettes
as conventional cigarettes.
There can be no assurance that our
X-22
smoking cessation aid will be approved by the FDA, European Medicines Agency (“EMA”), or any other governmental
body or that
BRAND A
and
BRAND B
will be approved by the FDA to be marketed as Modified Risk Cigarettes. In addition,
there can be no assurance that all necessary approvals will be granted for our potential products or that review or actions will
not involve delays caused by requests for additional information or testing that could adversely affect the time to market for
and sale of our potential products. Our ability to complete the FDA-approval process in a timely manner is dependent, in part,
on our ability to obtain “Fast Track” designation for
X-22
by the FDA.
The development, testing, manufacturing
and marketing of our potential products are subject to extensive regulation by governmental authorities in the United States and
throughout the world. In particular, the process of obtaining approvals by the FDA, the EMA and other international FDA equivalent
agencies in targeted countries is costly and time consuming, and the time required for such approval is uncertain. Our
X-22
smoking cessation aid must undergo rigorous clinical testing and an extensive regulatory approval process mandated by the FDA or
EMA. Such regulatory review includes the determination of manufacturing capability and product performance. Generally, only a small
percentage of pharmaceutical products are ultimately approved for commercial sale.
The scope of review, including
product testing and exposure studies, to be required by the FDA under the Tobacco Control Act in order for cigarettes such
as
BRAND A
and
BRAND B
to be marketed as Modified Risk Cigarettes has not yet been fully established, even
though the FDA issued
Modified Risk Tobacco Product Applications Draft Guidance
on March 30, 2012. Our first
application for
BRAND A
as a Modified Risk Cigarette has experienced delays and took a year to obtain substantial feed
back from the FDA. We may be unsuccessful in establishing that
BRAND A
or
BRAND B
are Modified Risk Cigarettes,
and we may fail to demonstrate that either
BRAND A
or
BRAND B
significantly reduces exposure to certain tobacco
smoke toxins. Even upon demonstrating significant reduced exposure to nicotine and/or certain tobacco smoke toxins, the FDA
may decide that allowing a modified risk claim is not in the best interest of the public health, and the FDA may not allow us
to market our
BRAND A
and/or
BRAND B
cigarettes as Modified Risk Cigarettes. In addition, the time and cost
involved in obtaining such approvals may be longer and more costly than anticipated.
The FDA could force the removal of our products from the
U.S. market.
The FDA could force us to remove from the
U.S. market our tobacco products such as
RED SUN
or
MAGIC
since these are not grandfathered products under the Tobacco
Control Act, and the FDA could force us to remove from the U.S. market
BRAND A
and/or
BRAND B
even after FDA authorization
to market
BRAND A
and
BRAND B
as Modified Risk Cigarettes.
We intend to distribute and sell our potential products
outside of the United States, which will subject us to other regulatory risks.
In addition to seeking approval from
the FDA for our
X-22
smoking cessation aid in the United States, we intend to seek governmental approvals required to
market
X-22
and our other products in other countries. Marketing of our
products is not permitted in certain
countries until we have obtained required approvals or exemptions in the individual country. The regulatory review process
varies from country to country, and approval by foreign governmental authorities is unpredictable, uncertain and generally
expensive. Our ability to market our potential products could be substantially limited due to delays in receipt of, or
failure to receive, the necessary approvals or clearances. We anticipate commencing the applications required in some or all
of these countries following approval by the FDA; however, we may decide to file applications in advance of the FDA approval
if we determine such filings to be both time and cost effective. If we export any of our potential products or products that
have not yet been cleared for commercial distribution in the United States, such products may be subject to FDA export
restrictions. Failure to obtain necessary regulatory approvals could impair our ability to generate revenue from
international sources.
Market acceptance of our X-22 smoking cessation aid could
be limited if users are unable to obtain adequate reimbursement from third-party payers.
Government health administration authorities,
private health insurers and other organizations generally provide reimbursement for FDA-approved smoking cessation products, and
our commercial success could depend in part on these third-party payers agreeing to reimburse patients for the costs of our
X-22
smoking cessation aid. Even if we succeed in bringing our
X-22
smoking cessation aid to market, there is no assurance
that third-party payers will consider
X-22
cost effective or provide reimbursement in whole or in part for its use.
Significant uncertainty exists as to the
reimbursement status of newly approved health care products. Our
X-22
smoking cessation aid is intended to replace or alter
existing therapies or procedures. These third-party payers may conclude that our
X-22
smoking cessation aid is less safe,
effective or cost-effective than these existing therapies or procedures. Therefore, third-party payers may not approve
X-22
for reimbursement.
If third-party payers do not approve
X-22
or our potential products for reimbursement or fail to reimburse for them adequately, sales could suffer as some physicians
or their patients could opt for a competing product that is approved for reimbursement or is adequately reimbursed. Even if third-party
payers make reimbursement available, these payers’ reimbursement policies may adversely affect our ability and the ability
of our potential collaborators to sell our potential products on a profitable basis.
The trend toward managed healthcare in
the United States, such as the Affordable Care Act enacted on March 23, 2010, and legislative proposals to reform healthcare and
government insurance programs could significantly influence the purchase of healthcare services and products, resulting in lower
prices and reduced demand for our potential products which could adversely affect our business, financial condition, results of
operations and cash flows.
In addition, legislation and regulations
affecting the pricing of our potential products may change in ways adverse to us before or after the FDA or other regulatory agencies
approve any of our potential products for marketing. While we cannot predict the likelihood of any of these legislative or regulatory
proposals, if any government or regulatory agency adopts these proposals, they could materially adversely affect our business,
financial condition, results of operations and cash flows.
Our clinical trials for any of our potential products
may produce negative or inconclusive results and we may decide, or regulators may require us, to conduct additional clinical and/or
preclinical testing for these potential products or cease our trials.
We do not know whether clinical trials
of our potential products will demonstrate safety and efficacy sufficiently to result in marketable products. Because our clinical
trials for our
X-22
smoking cessation aid and any other potential products may produce negative or inconclusive results,
we may decide, or regulators may require us, to conduct additional clinical and/or preclinical testing for these potential products
or cease our clinical trials. If this occurs, we may not be able to obtain approval or marketing authorization for these potential
products or our anticipated time of bringing these potential products to the market may be substantially delayed and we may also
experience significant additional development costs. We may also be required to undertake additional clinical testing if we change
or expand the indications for our potential products.
Risks Related to the Tobacco Industry
Our business faces significant governmental action aimed
at increasing regulatory requirements with the goal of preventing the use of tobacco products.
Cigarette companies face significant governmental
action, especially in the United States pursuant to the Tobacco Control Act, including efforts aimed at reducing the incidence
of tobacco use, restricting marketing and advertising, imposing regulations on packaging, warnings and disclosure of flavors or
other ingredients, prohibiting the sale of tobacco products with certain flavors or other characteristics, limiting or prohibiting
the sale of tobacco products by certain retail establishments and the sale of tobacco products in certain packaging sizes, and
seeking to hold retailers and distributors responsible for the adverse health effects associated with both smoking and exposure
to environmental tobacco smoke. Governmental actions, combined with the diminishing social acceptance of smoking and private actions
to restrict smoking, have resulted in reduced industry volume in the United States and certain other countries, and we expect that
these factors will continue to reduce consumption levels in these countries.
Certain of such actions may have a favorable
impact on our
X-22
smoking cessation aid, or on our
BRAND A
and
BRAND B
cigarettes if we are able to market
them as Modified Risk Cigarettes. However, there is no assurance of such favorable impact and such actions may have a negative
impact on our ability to market
RED SUN
and
MAGIC
.
Significant regulatory developments will
take place over the next few years in many markets, driven principally by the World Health Organization’s Framework Convention
on Tobacco Control (“FCTC”). The FCTC is the first international public health treaty on tobacco, and its objective
is to establish a global agenda for tobacco regulation with the purpose of reducing initiation of tobacco use and encouraging cessation.
In addition, the FCTC has led to increased efforts by tobacco control advocates and public health organizations to reduce the appeal
of tobacco products. Partly because of some or a combination of these efforts, unit sales of tobacco products in certain markets,
principally Western Europe and Japan, have been in general decline and we expect this trend to continue. Our operating results
could be significantly affected by any significant decrease in demand for cigarettes, any significant increase in the cost of complying
with new regulatory requirements and requirements that lead to a commoditization of tobacco products such as the implementation
of plain packaging in Australia.
If implemented in the future, the FDA requirement regarding
graphic health warnings on cigarette packaging and in cigarette advertising is likely to have a negative impact on sales of our
products.
In November 2010, as required by the Tobacco
Control Act, the FDA issued a proposed rule to modify the required warnings that appear on cigarette packages and in cigarette
advertisements. These warning were finalized on June 21, 2011 and consisted of nine new textual warning statements accompanied
by color graphics depicting the negative health consequences of smoking. The FDA selected nine images from the originally proposed
36 images after reviewing the relevant scientific literature, analyzing the results from an 18,000 person study and considering
more than 1,700 comments from a variety of groups. The graphic health warnings were to be located beneath the cellophane wrapping
on cigarette packages, and were to comprise the top 50 percent of the front and rear panels of cigarette packages. Although these
graphic health warnings were supposed to be implemented in September 2012, a federal judge ruled that these warnings are unconstitutional.
If and when these graphic health warnings are implemented, all cigarettes manufactured for sale or distribution in the United
States will need to include these new graphic health warnings on their packages. Any reduction in the number of smokers will probably
reduce the demand for our products.
We may become subject to litigation related to cigarette
smoking and exposure to environmental tobacco smoke, or ETS, which could severely impair our results of operations and liquidity.
Although we are not currently subject
to legal proceedings related to cigarette smoking or ETS, we may become subject to litigation related to the sale of our
RED
SUN
and
MAGIC
cigarettes and, upon FDA authorization, our
BRAND A
and
BRAND B
cigarettes. Legal
proceedings covering a wide range of matters related to tobacco use are pending or threatened in various U.S. and foreign
jurisdictions. Various types of claims are raised in these proceedings, including product liability, consumer protection,
antitrust, tax, contraband shipments, patent infringement, employment matters, claims for contribution and claims of
competitors and distributors.
Litigation is subject to uncertainty and
it is possible that there could be adverse developments in pending cases. An unfavorable outcome or settlement of pending tobacco
related litigation could encourage the commencement of additional litigation. The variability in pleadings, together with the actual
experience of management in litigating claims, demonstrates that the monetary relief that may be specified in a lawsuit bears little
relevance to the ultimate outcome.
Damages claimed in some tobacco-related
litigation are significant and, in certain cases range into the billions of dollars. We anticipate that new cases will continue
to be filed. The FCTC encourages litigation against tobacco product manufacturers. It is possible that our results of operations,
cash flows or financial position could be materially affected by an unfavorable outcome or settlement of litigation.
Cigarettes are subject to substantial taxes. Significant
increases in cigarette-related taxes have been proposed or enacted and are likely to continue to be proposed or enacted in numerous
jurisdictions. These tax increases may affect our sales and profitability and make us less competitive versus certain of our competitors.
Tax regimes, including excise taxes, sales
taxes and import duties, can disproportionately affect the retail price of manufactured cigarettes versus other tobacco products,
or disproportionately affect the relative retail price of our
RED SUN
and
MAGIC
cigarettes and, upon FDA authorization,
our
BRAND A
and
BRAND B
cigarettes versus lower-priced cigarette brands manufactured by our competitors. Increases
in cigarette taxes are expected to continue to have an adverse impact on sales of cigarettes resulting in (i) lower consumption
levels, (ii) a shift in sales from manufactured cigarettes to other tobacco products or to lower-price cigarette categories, (iii)
a shift from local sales to legal cross-border purchases of lower price products, and (iv) illicit products such as contraband
and counterfeit.
We may become subject to governmental investigations on
a range of matters.
Tobacco companies are often subject to
investigations, including allegations of contraband shipments of cigarettes, allegations of unlawful pricing activities within
certain markets, allegations of underpayment of custom duties and/or excise taxes, and allegations of false and misleading usage
of descriptors such as “lights” and “ultra-lights.” We cannot predict the outcome of any to which we may
become subject, and we may be materially affected by an unfavorable outcome of future investigations.
Risks Related to Intellectual Property
Our proprietary rights may not adequately protect our
intellectual property, products and potential products, and if we cannot obtain adequate protection of our intellectual property,
products and potential products, we may not be able to successfully market our products and potential products.
Our commercial success will depend in part
on obtaining and maintaining intellectual property protection for our technologies, products and potential products. We will only
be able to protect our technologies, products and potential products from unauthorized use by third parties to the extent that
valid and enforceable patents cover them, or other market exclusionary rights apply.
The patent positions of life sciences companies,
like ours, can be highly uncertain and involve complex legal and factual questions for which important legal principles remain
unresolved. No consistent policy regarding the breadth of claims allowed in such companies’ patents has emerged to date in
the United States. The general patent environment outside the United States also involves significant uncertainty. Accordingly,
we cannot predict the breadth of claims that may be allowed or that the scope of these patent rights could provide a sufficient
degree of future protection that could permit us to gain or keep our competitive advantage with respect to these products and technology.
Additionally, life science companies like ours are often dependent on creating a pipeline of products. We may not be able to develop
additional potential products or proprietary technologies that produce commercially viable products or that are themselves patentable.
Although there are currently no challenges
to any portion of our intellectual property, our issued patents may be subject to challenge and possibly invalidated by third parties.
Changes in either the patent laws or in the interpretations of patent laws in the United States or other countries may diminish
the value of our intellectual property. In addition, others may independently develop similar or alternative products and technologies
that may be outside the scope of our intellectual property. Should third parties obtain patent rights to similar products or technology,
this may have an adverse effect on our business.
We also rely on trade secrets to protect
our technology, products and potential products, especially where we do not believe patent protection is appropriate or obtainable.
Trade secrets, however, are difficult to protect. While we believe that we use reasonable efforts to protect our trade secrets,
our own, our licensees’ or our strategic partners’ employees, consultants, contractors or advisors may unintentionally
or willfully disclose our information to competitors. We seek to protect this information, in part, through the use of non-disclosure
and confidentiality agreements with employees, consultants, advisors and others. These agreements may be breached, and we may not
have adequate remedies for a breach. In addition, we cannot ensure that those agreements will provide adequate protection for our
trade secrets, know-how or other proprietary information or prevent their unauthorized use or disclosure.
To the extent that consultants or key employees
apply technological information independently developed by them or by others to our products and potential products, disputes may
arise as to the proprietary rights of the information, which may not be resolved in our favor. Key employees are required to assign
all intellectual property rights in their discoveries to us. However, these key employees may terminate their relationship with
us, and we cannot preclude them indefinitely from dealing with our competitors. If our trade secrets become known to competitors
with greater experience and financial resources, the competitors may copy or use our trade secrets and other proprietary information
in the advancement of their products, methods or technologies. If we were to prosecute a claim that a third party had illegally
obtained and was using our trade secrets, it could be expensive and time consuming and the outcome could be unpredictable. In addition,
courts outside the United States are sometimes less willing to protect trade secrets than courts in the United States. Moreover,
if our competitors independently develop equivalent knowledge, we would lack any contractual claim to this information, and our
business could be harmed.
The ability to commercialize our potential products will
depend on our ability to sell such products without infringing the patent or proprietary rights of third parties. If we are sued
for infringing intellectual property rights of third parties, such litigation could be costly and time consuming and an unfavorable
outcome could have a significant adverse effect on our business.
The ability to commercialize our potential
products will depend on our ability to sell such products without infringing the patents or other proprietary rights of third parties.
Third-party intellectual property rights in our field are complicated, and third-party intellectual property rights in these fields
are continuously evolving. While we have conducted searches for such third-party intellectual property rights, we have not performed
specific searches for third-party intellectual property rights that may raise freedom-to-operate issues, and we have not obtained
legal opinions regarding commercialization of our potential products. As such, there may be existing patents that may affect our
ability to commercialize our potential products.
In addition, because patent applications
are published up to 18 months after their filing, and because patent applications can take several years to issue, there may be
currently pending third-party patent applications and freedom-to-operate issues that are unknown to us, which may later result
in issued patents.
If a third-party claims that we infringe
on its patents or other proprietary rights, we could face a number of issues that could seriously harm our competitive position,
including:
|
·
|
infringement claims that,
with or without merit, can be costly and time consuming to litigate, can delay the regulatory approval process and can divert
management’s attention from our core business strategy;
|
|
·
|
substantial damages for
past infringement which we may have to pay if a court determines that our products or technologies infringe upon a competitor’s
patent or other proprietary rights;
|
|
·
|
a court order prohibiting
us from commercializing our potential products or technologies unless the holder licenses the patent or other proprietary rights
to us, which such holder is not required to do;
|
|
·
|
if a license is available
from a holder, we may have to pay substantial royalties or grant cross licenses to our patents or other proprietary rights; and
|
|
·
|
redesigning our process
so that it does not infringe the third-party intellectual property, which may not be possible, or which may require substantial
time and expense including delays in bringing our potential products to market.
|
Such actions could harm our competitive
position and our ability to generate revenue and could result in increased costs.
Our patent applications may not result in issued patents,
which may have a material adverse effect on our ability to prevent others from commercially exploiting products similar to ours.
We own or exclusively control more than
200 issued patents plus more than 50 pending patent applications. We cannot assure you these patent applications will issue, in
whole or in part, as patents. Patent applications in the United States are maintained in secrecy until the patents are published
or are issued. Since publication of discoveries in the scientific or patent literature tends to lag behind actual discoveries by
several months, we cannot be certain that we are the first creator of inventions covered by pending patent applications or the
first to file patent applications on these inventions. We also cannot be certain that our pending patent applications will result
in issued patents or that any of our issued patents will afford protection against a competitor. In addition, patent applications
filed in foreign countries are subject to laws, rules and procedures that differ from those of the United States, and thus we cannot
be certain that foreign patent applications related to U.S. patents will be issued. Furthermore, if these patent applications issue,
some foreign countries provide significantly less effective patent enforcement than in the United States.
The status of patents involves complex
legal and factual questions and the breadth of claims allowed is uncertain. Accordingly, we cannot be certain that the patent applications
that we or our licensors file will result in patents being issued, or that our patents and any patents that may be issued to us
in the near future will afford protection against competitors with similar technology. In addition, patents issued to us may be
infringed upon or designed around by others and others may obtain patents that we need to license or design around, either of which
would increase costs and may adversely affect our operations.
We license certain patent rights from third-party owners.
If such owners do not properly maintain or enforce the patents underlying such licenses, our competitive position and business
prospects could be harmed.
We license rights to third-party intellectual
property that is necessary or useful for our business, and we may enter into additional licensing agreements in the future. Our
success could depend in part on the ability of some of our licensors to obtain, maintain and enforce patent protection for their
intellectual property, in particular, those patents to which we have secured exclusive rights. Our licensors may not successfully
prosecute the patent applications to which we are licensed. Even if patents are issued with respect to these patent applications,
our licensors may fail to maintain these patents, may determine not to pursue litigation against other companies that are infringing
these patents, or may pursue such litigation less aggressively than we could. Without protection for the intellectual property
we license, other companies might be able to offer substantially identical products for sale, which could adversely affect our
competitive business position and harm our business prospects.
Our worldwide exclusive licenses relating
to tobacco from NCSU involves multiple patent families. The exclusive rights under the NCSU agreements expire on the date on which
the last patent or registered plant variety covered by the subject license expires in the country or countries where such patents
or registered plant varieties are in effect. The NCSU licenses relate predominately to issued patents, and our exclusive rights
in the NCSU licenses will expire in 2023.
Our worldwide sublicense
from Anandia, a plant biotechnology company based in Vancouver, Canada, grants us exclusive rights in the United States
and co-exclusive rights with Anandia everywhere else in the world (except not in Canada where Anandia retains exclusive
rights) to 2 U.S. patents and 23 patent applications relating to four genes in the cannabis plant that are required for the
production of cannabinoids, the active ingredients in the cannabis plant. The Anandia sublicense continues through the life
of the last-to-expire patent, which is expected to be in 2035.
Risks Related to Ownership of Our Common Stock
An active trading market for our common stock may not
be sustained, and you may not be able to resell your shares at or above the price at which you purchased them.
An active trading market for our shares
may not be sustained. In the absence of an active trading market for our common stock, shares of common stock may not be able to
be resold at or above the purchase price of such shares. Although there can be no assurances, we expect that our common stock will
continue to be quoted on the New York Stock Exchange MKT (NYSE MKT) on which the shares of our common stock are currently quoted.
However, even if our common stock continues to be quoted on the NYSE MKT, there is no assurance that an active market for our common
stock will continue in the foreseeable future. There also can be no assurance that we can maintain such listing on the NYSE MKT.
It may be more difficult to dispose of shares or obtain accurate quotations as to the market value of our common stock compared
to securities of companies whose shares are traded on national stock exchanges.
Our stock price may be highly volatile and could decline
in value.
Our common stock is currently traded on
the NYSE MKT and the market prices for our common stock have been volatile. Further, the market prices for securities in general
have been highly volatile and may continue to be highly volatile in the future. The following factors, in addition to other risk
factors described in this section, may have a significant impact on the market price of our common stock:
|
·
|
results from and any
delays in any clinical trials programs;
|
|
·
|
failure or delays in
entering potential products into clinical trials;
|
|
·
|
failure or discontinuation
of any of our research programs;
|
|
·
|
delays in establishing
new strategic relationships;
|
|
·
|
delays in the development
of our potential products and commercialization of our potential products;
|
|
·
|
market conditions in
our sector and issuance of new or changed securities analysts’ reports or recommendations;
|
|
·
|
general economic conditions,
including recent adverse changes in the global financial markets;
|
|
·
|
actual and anticipated
fluctuations in our quarterly financial and operating results;
|
|
·
|
developments or disputes
concerning our intellectual property or other proprietary rights;
|
|
·
|
introduction of technological
innovations or new commercial products by us or our competitors;
|
|
·
|
issues in manufacturing
or distributing our products or potential products;
|
|
·
|
market acceptance of
our products or potential products;
|
|
·
|
third-party healthcare
reimbursement policies;
|
|
·
|
FDA or other United States
or foreign regulatory actions affecting us or our industry;
|
|
·
|
litigation or public
concern about the safety of our products or potential products;
|
|
·
|
additions or departures
of key personnel;
|
|
·
|
third-party sales of
large blocks of our common stock;
|
|
·
|
sales of our common stock
by our executive officers, directors or significant stockholders; and
|
|
·
|
equity sales by us of
our common stock or securities convertible into common stock to fund our operations.
|
These and other external factors may cause
the market price and demand for our common stock to fluctuate substantially, which may limit or prevent investors from readily
selling their shares of common stock and may otherwise negatively affect the liquidity of our common stock. In addition, in the
past, when the market price of a stock has been volatile, holders of that stock have instituted securities class action litigation
against the company that issued the stock. If any of our stockholders brought a lawsuit against us, we could incur substantial
costs defending the lawsuit. Such a lawsuit could also divert the time and attention of our management.
Future sales of our common stock will result in dilution
to our common stockholders.
Sales of a substantial number of shares
of our common stock in the public market may depress the prevailing market price for our common stock and could impair our ability
to raise capital through the future sale of our equity securities. Additionally, if the holders of outstanding options or warrants
exercise or convert those shares, as applicable, our common stockholders will incur dilution in their relative percentage ownership.
The prospect of this possible dilution may also impact the price of our common stock.
We do not expect to declare any dividends on our common
stock in the foreseeable future.
We have not paid cash dividends to date
on our common stock. We currently intend to retain our future earnings, if any, to fund the development and growth of our business,
and we do not anticipate paying any cash dividends on our common stock for the foreseeable future. Additionally, the terms of any
future debt facilities may preclude us from paying dividends on the common stock. As a result, capital appreciation, if any, of
our common stock could be the sole source of gain for the foreseeable future.
Anti-takeover provisions contained in our articles of
incorporation and bylaws, as well as provisions of Nevada law, could impair a takeover attempt.
Our amended and restated articles of incorporation
and bylaws currently contain provisions that, together with Nevada law, could have the effect of rendering more difficult or discouraging
an acquisition deemed undesirable by our board of directors. Our corporate governance documents presently include the following
provisions:
|
·
|
providing for a “staggered”
board of directors in which only one-third (1/3) of the directors can be elected in any year;
|
|
·
|
authorizing blank check
preferred stock, which could be issued with voting, liquidation, dividend and other rights superior to our common stock; and
|
|
·
|
limiting the liability
of, and providing indemnifications to, our directors and officers.
|
These provisions, alone or together, could
delay hostile takeovers and changes in control of us or changes in our management.
As a Nevada corporation, we also may become
subject to the provisions of Nevada Revised Statutes Sections 78.378 through 78.3793, which prohibit an acquirer, under certain
circumstances, from voting shares of a corporation’s stock after crossing specific threshold ownership percentages, unless
the acquirer obtains the approval of the stockholders of the issuer corporation. The first such threshold is the acquisition of
at least one-fifth, but less than one-third of the outstanding voting power of the issuer. We may become subject to the above referenced
Statutes if we have 200 or more stockholders of record, at least 100 of whom are residents of the State of Nevada, and do business
in the State of Nevada directly or through an affiliated corporation.
As a Nevada corporation, we are subject
to the provisions of Nevada Revised Statutes Sections 78.411 through 78.444, which prohibit an “interested stockholder”
from entering into a combination with the corporation, unless certain conditions are met. An “interested stockholder”
is a person who, together with affiliates and associates, beneficially owns (or within the prior two years did own) 10 percent
or more of the corporation’s voting stock.
Any provision of our amended and restated
articles of incorporation, our bylaws or Nevada law that has the effect of delaying or deterring a change in control of our Company
could limit the opportunity for our stockholders to receive a premium for their shares of our common stock, and could also affect
the price that some investors are willing to pay for our common stock.
|
Item 1B
|
Unresolved Staff Comments.
|
None.
Our principal administrative offices are located
in Clarence, New York. We currently lease 3,800 square feet of office space. The lease expires on August 31, 2017. Scheduled rent
remaining as of December 31, 2016, is approximately $31,000 for 2017.
We have a lease for our warehouse and cigarette
manufacturing facility located in North Carolina. The lease commenced on January 14, 2014, and had an initial term of twelve
(12) months. The lease contains four (4) additional extensions; with one lease extension being for an additional one (1) year and
with the other three (3) lease extensions each being for an additional two (2) years in duration, exercisable at our option. We
are currently in the first of a two-year lease extension term that will expire on October 31, 2018. The lease expense for the years
ended December 31, 2016, 2015 and 2014 amounted to approximately $146,000, $127,000 and $98,000, respectively. The future minimum
lease payments if we exercise each of the additional extensions are approximately as follows:
Year ended December 31, 2017 -
|
|
$
|
156,000
|
|
Year ended December 31, 2018 -
|
|
$
|
169,000
|
|
Year ended December 31, 2019 -
|
|
$
|
169,000
|
|
Year ended December 31, 2020 -
|
|
$
|
169,000
|
|
Year ended December 31, 2021 -
|
|
$
|
141,000
|
|
On November 1, 2015, we entered into a one-year
lease for 25,000 square feet of warehouse space in North Carolina to store the Company’s proprietary tobacco leaf. The lease
calls for a monthly lease payment of $3,750 and contains a three-year renewal option after the initial one-year term. In October
of 2016, we exercised the three-year renewal option under this lease. Future minimum lease payments for the years ended December
31, 2017, 2018 and 2019 will be $45,000, $45,000 and $37,500, respectively.
On May 1, 2016, we entered into
a sublease for laboratory space in Buffalo, New York. The sublease calls for a monthly payment of $1,471, expires on April 30,
2017 and contains an option to extend the lease for a period of one year through April 30, 2018. Future minimum sublease payments
for the years ended December 31, 2017 and 2018 are approximately $18,000 and $6,000, respectively, if the Company exercises the
optional renewal period.
On September 1, 2016, we
entered into a sublease for warehouse space in North Carolina to store and operate tobacco leaf processing equipment. The
sublease calls for a monthly payment of $1,200, expires on August 31, 2017 and contains twelve-month renewal options as
long as the sublessor continues to sublease the warehouse. Future minimum sublease payments for the year ending December 31,
2017 are $14,400 per year and for each subsequent year the warehouse space is sublet by the Company.
|
Item 3.
|
Legal Proceedings.
|
From time to time we may be involved
in claims arising in the ordinary course of business. To our knowledge other than the case described below, no material legal
proceedings, governmental actions, investigations or claims are currently pending against us or involve us that, in the
opinion of our management, could reasonably be expected to have a material adverse effect on our business and financial
condition.
On April 26, 2016, Crede CG III, LTD. (“Crede”)
filed a complaint against the Company in the United States District Court for the Southern District of New York (the “SDNY
Court”) entitled
Crede CG III, LTD. v. 22nd Century Group, Inc
. On May 19, 2016, Crede filed an Amended
Complaint that includes seven counts, alleging among other things, that the Company allegedly breached and/or interfered with certain
agreements entered into with Crede, including the joint venture agreement relating to efforts to sell the Company’s proprietary
tobacco into China, the Tranche 1A warrant and the prior securities purchase agreement with Crede. The Amended Complaint
seeks money damages, to rescind the securities purchase agreement, to obtain declaratory and injunctive relief to require the Company
to issue to Crede 2,077,555 shares of the Company’s common stock under the exchange provision of the Tranche 1A warrant,
and entry of an injunction prohibiting the Company from selling tobacco into China without the joint venture’s involvement.
The Amended Complaint also seeks attorney’s fees and such other relief as the Court may deem just and proper. We believe
that the claims are frivolous, meritless and that the Company has substantial legal and factual defenses to the claims.
On May 19, 2016, Crede filed a motion for preliminary
injunction, asking the SDNY Court to require the Company to issue 2,077,555 shares of its common stock to Crede under the exchange
provision of the Tranche 1A warrant. After conducting an evidentiary hearing on this motion on June 14, 2016, the SDNY Court
denied Crede’s motion and held, among other things, that Crede did not prove the potential for irreparable harm or a likelihood
of success on its claim for such 2,077,555 shares under the Tranche 1A warrant, and that there was a likelihood that Crede had
violated the activity restrictions of the Tranche 1A warrant, which would bar Crede’s claim for such shares from the Company.
Following such ruling, on July 11, 2016, the Company
filed a motion to sever the Crede lawsuit into two separate cases, requesting all claims relating to the Tranche 1A warrant and
the securities purchase agreement to stay in the SDNY Court and all claims relating to the China joint venture agreement to be
transferred to the United States District Court for the Western District of New York (the “WDNY Court”), where the
Company’s headquarters are located. On January 20, 2017, the SDNY Court granted the Company’s motion.
On February 14, 2017, Crede voluntarily dismissed
its lawsuit against the Company in the WDNY Court.
On February 21, 2017, the SDNY Court granted the
Company’s request to file a motion for summary judgment for the claims remaining in the SDNY Court, with all discovery in
the case being deferred until after the SDNY Court conducts a hearing and issues its decision on the summary judgment motion to
be filed by the Company.
We
believe that the claims are frivolous, meritless and that the Company has substantial legal and factual defenses to the claims.
The Company has defended and intends to continue to defend against these claims vigorously.
|
Item 4.
|
Mine Safety Disclosures.
|
Not applicable
NOTE 1. - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
Principles of Consolidation
-
The accompanying consolidated financial statements include the accounts of 22nd Century Group, Inc. (“22nd Century Group”),
its three wholly-owned subsidiaries, 22nd Century Limited, LLC (“22nd Century Ltd”), NASCO Products, LLC (“NASCO”),
and Botanical Genetics, LLC (“Botanical Genetics”), and two wholly-owned subsidiaries of 22nd Century Ltd, Goodrich
Tobacco Company, LLC (“Goodrich Tobacco”) and Heracles Pharmaceuticals, LLC (“Heracles Pharma”, formerly
known as Hercules Pharmaceuticals, LLC) (collectively, the “Company”). All intercompany accounts and transactions
have been eliminated.
Nature of Business
-
22nd Century Ltd is a plant biotechnology company specializing in technology that allows for the level of nicotine and other
nicotinic alkaloids (e.g., nornicotine, anatabine and anabasine) in tobacco plants to be decreased or increased through genetic
engineering and plant breeding. The Company currently owns or exclusively controls more than 200 issued patents and more than
50 pending patent applications around the world. Goodrich Tobacco and Heracles Pharma are business units for the Company’s
(i) premium cigarettes and potential modified risk tobacco products and (ii) smoking cessation product, respectively. The Company
acquired the membership interests of NASCO on August 29, 2014. NASCO is a federally licensed tobacco products manufacturer, a
participating member of the tobacco Master Settlement Agreement (“MSA”) between the tobacco industry and the Settling
States under the MSA, and operates the Company’s cigarette manufacturing business in North Carolina. Botanical Genetics
is a wholly-owned subsidiary of 22nd Century Group, and was incorporated to facilitate an equity investment more fully described
in Note 9.
Reclassifications
-
Certain items in the 2015 and 2014 financial statements have been reclassified to conform to the 2016 classification.
Preferred stock authorized
-
The Company is authorized to issue “blank check” preferred stock, which could be issued with voting, liquidation,
dividend and other rights superior to our common stock.
Concentration of Credit Risk
-
Financial instruments that potentially subject the Company to concentration of credit risk consist of cash accounts
in financial institutions. Although the cash accounts exceed the federally insured deposit amount, management does not anticipate
nonperformance by the financial institutions. Management reviews the financial viability of these institutions on a periodic basis.
Accounts receivable
-
The Company periodically reviews aged account balances for collectability. As of December 31, 2016 and 2015, the
Company has established an allowance for doubtful accounts in the amount of $10,000.
Inventory
-
Inventories
are valued at the lower of cost or market. Cost is determined using an average cost method for tobacco leaf inventory and raw
materials inventory and standard cost is primarily used for finished goods inventory. Inventories are evaluated to determine whether
any amounts are not recoverable based on slow moving or obsolete condition and are written off or reserved as appropriate. Inventories
at December 31, 2016 and December 31, 2015 consisted of the following:
|
|
December
31,
2016
|
|
|
December
31,
2015
|
|
|
|
|
|
|
|
|
Inventory – tobacco leaf
|
|
$
|
1,936,039
|
|
|
$
|
1,816,857
|
|
Inventory – finished goods
|
|
|
|
|
|
|
|
|
Cigarettes and filtered cigars
|
|
|
340,523
|
|
|
|
342,707
|
|
Inventory – raw materials
|
|
|
|
|
|
|
|
|
Cigarette and filtered cigar components
|
|
|
1,071,747
|
|
|
|
657,389
|
|
|
|
|
3,348,309
|
|
|
|
2,816,953
|
|
Less: inventory reserve
|
|
|
255,623
|
|
|
|
110,623
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
3,092,686
|
|
|
$
|
2,706,330
|
|
Fixed assets
-
Fixed assets
are recorded at their acquisition cost and depreciated on a straight-line basis over their estimated useful lives ranging from
3 to 10 years. Depreciation commences when the asset is placed in service.
Intangible Assets
-
Intangible
assets are recorded at cost and consist primarily of (1) expenditures incurred with third parties related to the processing of
patent claims and trademarks with government authorities, as well as costs to acquire patent rights from third parties, (2) license
fees paid for third-party intellectual property, (3) costs to become a signatory under the tobacco MSA, and (4) license fees paid
to acquire a predicate cigarette brand. The amounts capitalized relate to intellectual property that the Company owns or to which
it has exclusive rights. The Company’s intellectual property capitalized costs are amortized using the straight-line method
over the remaining statutory life of the primary patent in each of the Company’s two primary patent families, which expire
in 2019 and 2028 (the assets’ estimated lives), respectively. Periodic maintenance or renewal fees are expensed as incurred. Annual
minimum license fees are charged to expense. License fees paid for third-party intellectual property are amortized on a straight-line
basis over the last to expire patents, which patent expiration dates range from 2028 through 2035. The Company believes costs
associated with becoming a signatory to the MSA and acquiring the predicate cigarette brand have an indefinite life and as such,
no amortization is taken. Total intangible assets at December 31, 2016 and 2015 consist of the following:
|
|
December
31,
2016
|
|
|
December
31,
2015
|
|
Intangible assets, net
|
|
|
|
|
|
|
|
|
Patent and trademark costs
|
|
$
|
5,688,440
|
|
|
$
|
5,146,559
|
|
Less: accumulated amortization
|
|
|
2,021,926
|
|
|
|
1,603,893
|
|
Patent and trademark costs, net
|
|
|
3,666,514
|
|
|
|
3,542,666
|
|
|
|
|
|
|
|
|
|
|
License fees, net (see Note 14)
|
|
|
1,450,000
|
|
|
|
1,450,000
|
|
Less: accumulated amortization
|
|
|
228,568
|
|
|
|
130,546
|
|
License fees, net
|
|
|
1,221,432
|
|
|
|
1,319,454
|
|
|
|
|
|
|
|
|
|
|
MSA signatory costs
|
|
|
2,202,000
|
|
|
|
2,202,000
|
|
|
|
|
|
|
|
|
|
|
License fee for predicate cigarette brand
|
|
|
300,000
|
|
|
|
300,000
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
7,389,946
|
|
|
$
|
7,364,120
|
|
Amortization expense relating to the above
intangible assets for the years ended December 31, 2016, 2015 and 2014 amounted to $516,056, $454,612 and $265,284, respectively.
The estimated annual average amortization expense
for the next five years is approximately $353,000 for patent costs and $98,000 for license fees.
Impairment of Long-Lived Assets
-
The Company reviews the carrying value of its amortizing long-lived assets whenever events or changes in circumstances indicate
that the historical cost-carrying value of an asset may no longer be recoverable. The Company assesses recoverability of the asset
by estimating the future undiscounted net cash flows expected to result from the asset, including eventual disposition. If the
estimated future undiscounted net cash flows are less than the carrying value of the asset, an impairment loss is recorded equal
to the difference between the asset’s carrying value and its fair value. There was no impairment loss recorded during the
years ended December 31, 2016, 2015 or 2014.
Income Taxes
-
The Company recognizes
deferred tax assets and liabilities for any basis differences in its assets and liabilities between tax and GAAP reporting, and
for operating loss and credit carry-forwards.
Considering the Company’s history of
cumulative net operating losses and the uncertainty of their future utilization, the Company has established a valuation allowance
to fully offset its net deferred tax assets as of December 31, 2016 and 2015.
The Company’s federal and state tax returns
for the years ended December 31, 2013 through December 31, 2015 are currently open to audit under the statutes of limitations.
There are no pending audits as of December 31, 2016.
Stock Based Compensation
- The
Company uses a fair-value based method to determine compensation for all arrangements under which Company employees and others
receive shares or options to purchase common shares of the Company. Stock based compensation expense is recorded over the requisite
service period based on estimates of probability and time of achieving milestones and vesting. For accounting purposes, the shares
will be considered issued and outstanding upon vesting.
Revenue Recognition -
The Company
recognizes revenue from product sales at the point the product is shipped to a customer and title has transferred. Revenue
from the sale of the Company’s products is recognized net of cash discounts, sales returns and allowances. Cigarette and
filtered cigar federal excise taxes and other regulatory fees in the approximate amount of $7,452,000, $5,703,000 and $0 are included
in net sales for the years ended December 31, 2016, 2015 and 2014, respectively, except on sales of
SPECTRUM
research
cigarettes, exported cigarettes exported filtered cigars, and in-bond sales of filtered cigars to other federally licensed
tobacco product manufactures, to which such taxes do not apply. The Company recognizes revenue
from the sale of its
MAGIC
brand cigarettes in Europe when the cigarettes are sold by the European distributors to the
retailers and are sold net of cash discounts, sales returns and allowances, and all applicable taxes.
In 2010, the Company was chosen to be
a subcontractor for a 5-year government contract between RTI International (“RTI”) and the National Institute
on Drug Abuse (“NIDA”) to supply NIDA with research cigarettes. The contract was renewed in 2015 for an
additional 5 years. These government research cigarettes are distributed under the Company’s mark
SPECTRUM
. In
September 2015, the Company received a purchase order for approximately 5.0 million
SPECTRUM
research cigarettes.
Approximately 40% of the order was shipped in December 2015, resulting in the recognition of revenue in the amount of
$242,658 during the fourth quarter of 2015. The remainder of the order was shipped in January of 2016 and generated revenue
of $329,321. There were no
SPECTRUM
cigarettes delivered during the balance of 2016.
Derivatives
-
The Company
does not use derivative instruments to hedge exposures to cash flow, market or foreign currency risks. The Company evaluates all
our financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives.
For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at
its fair market value and then is revalued at each reporting date, with changes in fair value reported in the Consolidated Statements
of Operations. The methodology for valuing our outstanding warrants classified as derivative instruments utilizes a lattice model
approach which includes probability weighted estimates of future events, including volatility of our common stock. The classification
of derivative instruments, including whether such instruments should be recorded as liabilities or equity, is evaluated at the
end of each reporting period. Derivative instrument liabilities are classified on the balance sheet as current or non-current
based on if the net-cash settlement of the derivative instrument could be required within twelve months of the balance sheet date.
Research and Development
-
Research and development costs are expensed as incurred.
Advertising
- The Company
expenses advertising costs as incurred. Advertising expense was approximately $325,000, $229,000 and $30,000 for the years ended
December 31, 2016, 2015 and 2014, respectively.
Loss Per Common Share
-
Basic loss per common share is computed using the weighted-average number of common shares outstanding. Diluted loss per share
is computed assuming conversion of all potentially dilutive securities. Potential common shares outstanding are excluded from
the computation if their effect is anti-dilutive.
Commitment and Contingency Accounting
-
The Company evaluates each commitment and/or contingency in accordance with the accounting standards, which state that
if the item is more likely than not to become a direct liability, then the Company will record the liability in the financial
statements. If not, the Company will disclose any material commitments or contingencies that may arise.
Use of Estimates
-
The
preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management
to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period.
Actual results could differ from those estimates.
Fair Value of Financial Instruments
-
Financial instruments include cash, receivables, accounts payable, accrued expenses, accrued severance, note
payable and warrant liability. Other than warrant liability, fair value is assumed to approximate carrying values for these financial
instruments, since they are short term in nature, they are receivable or payable on demand, or had stated interest rates that
approximate the interest rates available to the Company as of the reporting date. The determination of the fair value of the warrant
liability includes unobservable inputs and is therefore categorized as a Level 3 measurement, as further discussed in Note 12.
Equity Investments -
The
Company accounts for investments in equity securities of other entities under the equity method of accounting if the Company’s
investment in the voting stock is greater than or equal to 20% and less than a majority, and the Company has the ability to have
significant influence over the operating and financial policies of the investee.
Accounting Pronouncements -
In
May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU 2014-09, “Revenue from Contracts
with Customers,” which supersedes nearly all existing revenue recognition guidance under GAAP. The core principle of
ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects
the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five-step
process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue
recognition process than are required under existing GAAP. The revised effective date for the ASU is for annual periods
beginning after December 15, 2017, and interim periods therein, using either of the following transition methods: (i) a full
retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect
certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09
recognized at the date of adoption (which includes additional footnote disclosures). In August 2015, the FASB issued ASU
2015-14, “Revenue from Contracts with Customers (Topic 606) - Deferral of the Effective Date,” which deferred the
effective date of ASU 2014-09 to annual reporting periods beginning after December 15, 2017, with earlier application
permitted as of annual reporting periods beginning after December 15, 2016. In March 2016, the FASB issued ASU No. 2016-08,
“Revenue from Contracts with Customers (Topic 606) - Principal versus Agent Considerations,” to clarify the
implementation guidance on principal versus agent. In April 2016, the FASB issued ASU No. 2016-10, “Revenue from
Contracts with Customers (Topic 606) - Identifying Performance Obligations and Licensing,” which clarifies the
identifying performance obligations and licensing implementation guidance. The Company will implement the applicable revenue
recognition ASU’s for annual reporting periods beginning after December 15, 2017. As a result of such
implementation the Company with exclude certain Federal excise and other regulatory fees from revenue and the cost of goods
sold.
In February 2016, the FASB issued ASU
2016-02, “Leases,” which supersedes existing lease guidance under GAAP. Under the new guidance, lessees will be required
to recognize leases as right of use assets and liabilities for leases with lease terms of more than twelve months. The guidance
will apply for both finance and operating leases. The effective date for the ASU is for annual periods beginning after December
15, 2018 and interim periods therein. The Company is currently evaluating the impact of the ASU on its consolidated financial
statements.
NOTE 2. – OCTOBER 2016 REGISTERED
DIRECT OFFERING
On October
19, 2016, the Company closed a registered direct offering with two institutional investors of units consisting
of 8,500,000 shares of the Company’s common stock and warrants to purchase 4,250,000 shares of the Company’s common
stock at an exercise price of $1.45 per share. The warrants are exercisable for a period of sixty-six (66) months after issuance,
are not exercisable for a period of six months immediately following the issuance and had a fair value of approximately $3,380,000
at issuance.
The holders of the warrants will not have the right to exercise any portion of the warrants if the holders,
together with its respective affiliates, would beneficially own in excess of 4.99% of the number of shares of the Company’s
common stock (including securities convertible into common stock) outstanding immediately after the exercise; provided, however,
that the holder may increase or decrease this limitation at any time, although any increase shall not be effective until the 61st
day following the notice of increase and the holder may not increase this limitation in excess of 9.99%.
The common stock and warrants were sold for $1.3425 per unit, resulting in net proceeds to the Company in the amount of $10,707,823,
after deducting expenses associated with the transaction.
NOTE 3. – JULY 2016 REGISTERED DIRECT
OFFERING
On July 27, 2016, the Company closed
a registered direct offering of units consisting of 6,172,840 shares of the Company’s common stock and
warrants to purchase 7,043,211 shares of the Company’s common stock. The warrants provide for an exercise price of $1.00
per share and 1,543,210 of the warrants were exercisable immediately and had a fair value of approximately $858,000 at issuance
and 5,500,001 of the warrants were exercisable six months from the date of issuance and had a fair value of approximately 3,058,000
at issuance. All the warrants have a term of 5.5 years. The common stock and warrants were sold for $0.81 per unit, resulting
in net proceeds to the Company in the amount of $4,682,764, after deducting expenses associated with the transaction. In addition,
on July 27, 2016, the Company terminated an aggregate of 5.5 million warrants with exercise prices of $1.21 and $1.25 per share
(see Note 4 – February 2016 Registered Direct Offering and Note 5 – June 2015 Registered Direct Offering for additional
information).
NOTE 4. - FEBRUARY 2016 REGISTERED DIRECT OFFERING
On February 5, 2016, the Company closed
a registered direct offering of units consisting of 5,000,000 shares of the Company’s common stock and
warrants to purchase 2,500,000 shares of the Company’s common stock at an exercise price of $1.21 per share. The warrants
were exercisable for a period of sixty-six (66) months after issuance, were not exercisable for a period of six months immediately
following the issuance and had a fair value of approximately $1,940,000 at issuance. The common stock and warrants were sold for
$1.10 per unit, resulting in net proceeds to the Company in the amount of $5,091,791, after deducting expenses associated with
the transaction. The warrants associated with this transaction were terminated on July 27, 2016 (see Note 3 – July 2016
Registered Direct Offering for additional information).
NOTE 5. - JUNE 2015 REGISTERED DIRECT OFFERING
On June 2, 2015, the
Company closed a registered direct offering of units consisting of 6,000,000 shares of the Company’s common stock and
warrants to purchase 3,000,000 shares of the Company’s common stock at an exercise price of $1.25 per share. The
warrants were exercisable for a period of sixty-six (66) months after issuance, were not exercisable for a period of six
months immediately following the issuance and had a fair value of approximately $2,067,000 at issuance. The common stock and
warrants were sold for $1.00 per unit, resulting in net proceeds to the Company in the amount of $5,576,083, after deducting
expenses associated with the transaction. The warrants associated with this transaction were terminated on July 27, 2016 (see
Note 3 – July 2016 Registered Direct Offering for additional information).
NOTE 6. - JOINT VENTURE, CONSULTING AGREEMENT AND ASSOCIATED
WARRANTS
On June 22, 2015, the Company terminated
its joint venture arrangement with Crede CG III, Ltd. (“Crede”) and a third-party due to non-performance and other
breaches of the arrangement by Crede and its principals. The Company also notified Crede that the Company reserved and did not
waive any rights that the Company may have to assert any and all claims that it may have against Crede, its employees, agents,
representatives or affiliates thereof, which are allowable by law or in equity, including claims for breach of the warrant agreements
entered into with Crede.
The six-month Consulting Agreement
(the “Consulting Agreement”), entered into with Crede on September 29, 2014, expired on March 29, 2015. The value
of the warrants issued in conjunction with the Consulting Agreement in the aggregate amount of $4,070,000 and initially recorded
as prepaid consulting fees have been fully amortized. The amortization of the prepaid consulting fees amounted to $1,978,785 and
$2,091,215 for the years ended December 31, 2015 and 2014, respectively, and are included in General and administrative expenses
in the Company’s Consolidated Statements of Operations. There was no amortization of prepaid consulting fees for the year
ended December 31, 2016.
Four tranches of warrants were issued
to Crede in conjunction with the Consulting Agreement as follows: Tranche 1A warrant to purchase 1,250,000 shares of Company common
stock, Tranche 1B warrant to purchase 1,000,000 shares of Company common stock, Tranche 2 warrant to purchase 1,000,000 shares
of Company common stock and Tranche 3 warrant to purchase 1,000,000 shares of Company common stock. The Tranche 1A warrant contained
an exchange rights clause that required derivative liability treatment under FASB ASC 480 - “Distinguishing Liabilities
from Equity.” The Company valued the derivative liability associated with the Tranche 1A warrant at inception at $2,810,000
and the liability was recorded on the Company’s Consolidated Balance Sheets in Warrant liability. In March 2016, the Company
provided notice to Crede that Crede repeatedly breached the activity restrictions contained in the warrants and because the terms
of the Tranche 1A warrant provide that the availability of the exchange feature was subject to compliance with such activity restrictions,
the exchange rights clause contained in the Tranche 1A warrant was no longer available and was thereafter void (although the remaining
amount of shares underlying the warrant without the exchange feature remained fully exercisable at $3.36 per share through the
warrant expiration date of September 29, 2016). Accordingly, the Company reclassified the warrant liability associated with the
Tranche 1A warrant to Capital in excess of par on its Consolidated Balance Sheets during March 2016. The Tranche 1A and Tranche
1B warrants all expired without exercise on September 29, 2016. (See Note 14 - Commitments and contingencies for additional information).
The Tranche 2 and Tranche 3 warrants
were not exercisable unless and until certain revenue milestones were attained, as defined in the prior joint venture agreement
between Crede and the Company. As stated above, the Company terminated the joint venture agreement on June 22, 2015. Accordingly,
such revenue milestones will never be satisfied and the Tranche 2 and Tranche 3 warrants will never be exercisable.
NOTE 7. - MANUFACTURING FACILITY
The Company’s manufacturing operations
at its North Carolina factory were not at full production capacity during the years ended December 31, 2016 and 2015, but the
Company continued manufacturing a third-party MSA cigarette brand, filtered cigars on a contract basis, and the Company’s
own proprietary cigarette brand,
RED SUN
. Raw material component costs, direct manufacturing costs, and an overhead
allocation are included in the Cost of goods sold and finished goods inventory. General and administrative expenses of the factory
amounted to $551,678 and $607,713 for the years ended December 31, 2016 and 2015, respectively.
The Company’s manufacturing operations
were primarily in a pre-manufacturing stage during the year ended December 31, 2014. During this period the Company incurred various
expenses to prepare the facility for production. Pre-manufacturing expenses incurred during the year ended December 31, 2014 amounted
to $1,176,676 and are reported as Pre-manufacturing facility costs on the Company’s Consolidated Statements of Operations.
NOTE 8. - MACHINERY AND EQUIPMENT
Machinery and equipment at December
31, 2016 and 2015 consists of the following:
|
|
December 31, 2016
|
|
|
December 31, 2015
|
|
Cigarette manufacturing equipment
|
|
$
|
3,193,580
|
|
|
$
|
3,016,246
|
|
Office furniture, fixtures and equipment
|
|
|
103,945
|
|
|
|
95,361
|
|
Laboratory equipment
|
|
|
19,076
|
|
|
|
-
|
|
|
|
|
3,316,601
|
|
|
|
3,111,607
|
|
Less: accumulated depreciation
|
|
|
881,938
|
|
|
|
555,814
|
|
Machinery and equipment, net
|
|
$
|
2,434,663
|
|
|
$
|
2,555,793
|
|
Depreciation expense was $326,124,
$319,699 and $230,012 for the years ended December 31, 2016, 2015 and 2014, respectively.
NOTE 9. - EQUITY INVESTMENT AND ADVANCE
On April 11, 2014, the Company, through
its wholly-owned subsidiary, Botanical Genetics, LLC, entered into an investment agreement (the “Agreement”) with
Anandia Laboratories, Inc., a Canadian plant biotechnology company (“Anandia”). The Agreement provided for the Company
to make an initial investment of $250,000 in Anandia in return for (i) a ten percent (10%) equity interest in Anandia, and (ii)
certain rights granted to the Company for four patent families (the “Intellectual Property”). The $250,000 investment
was made on April 14, 2014. On September 15, 2014, certain milestones were achieved triggering an additional cash investment in
Anandia in the amount of $450,000 in return for (i) an additional fifteen percent (15%) equity interest in Anandia, and (ii) a
worldwide sublicense agreement to the Intellectual Property, including exclusive rights within the U.S. In addition, the Company
issued 150,000 unregistered shares of the Company’s common stock to Anandia with a value on the day of issuance of September
15, 2014 in the amount of $394,500, and on March 31, 2015, the Company issued to Anandia an additional 377,906 unregistered shares
of the Company’s common stock with an aggregate market value of $325,000 at the time of the issuance in accordance with
the Agreement.
The Company uses the equity method
of accounting to record its 24.4% ownership interest in Anandia (ownership was 25% prior to a dilutive event on September 8, 2016).
As of December 31, 2016, and December 31, 2015, the Company’s equity investment balance in Anandia was $1,020,313 and $1,222,651,
respectively, and is classified within Other assets on the accompanying Consolidated Balance Sheets. As of September 15, 2014,
the carrying value of our investment in Anandia was approximately $1,199,000 in excess of our share of the book value of the net
assets of Anandia, with such difference being attributable to intangible assets. This intangible asset is being amortized over
the expected benefit period and this amortization expense of $57,648, $57,648 and $16,815 for the years ended December 31, 2016,
2015 and 2014, respectively, has been included in the Loss on equity investment in the accompanying Consolidated Statements of
Operations. In addition, the Company has recorded an equity loss of $144,690, 38,036 and $84,350 for the years ended December
31, 2016, 2015 and 2014, respectively, representing the Company’s portion of Anandia’s net losses, resulting in a
total loss on equity investment of $202,338, $95,684 and $101,165 for the years ended December 31, 2016, 2015 and 2014, respectively.
NOTE 10. - NOTES PAYABLE AND PATENT ACQUISITION
On December 22, 2014, the Company entered
into a Purchase Agreement (the “Purchase Agreement”) with the National Research Council of Canada (“NRC”)
to acquire certain patent rights that the Company had previously licensed from NRC under a license agreement between the parties.
The Purchase Agreement provided for payment by the Company to NRC for the NRC patent rights a total amount of $1,213,000, of which
$213,000 was paid in cash at the closing on December 23, 2014, and with the remaining $1,000,000 balance to be paid in three equal
installments of $333,333 in December of 2015, 2016 and 2017, respectively, with no interest on the installment payments unless
the Company defaults on any such installment payments. As such, the Company computed the present value of the note payable using
the Company’s incremental borrowing rate. The resulting present value of the note payable amounted to $925,730 at December
31, 2014. After the scheduled installment payments of $333,333 made by the Company to NRC on December 22, 2016 and 2015 and the
accretion of interest, the remaining present value of the note payable amounts to $307,938; with $307,938 and $0 recorded as the
current and long-term portion of the note payable, respectively, at December 31, 2016 ($616,520; with $308,582 and $307,938 as
the current and long-term portion of the note payable, respectively, at December 31, 2015). The cost of the acquired patents in
the amount of $1,138,730 (cash of $213,000 plus the original discounted notes payable in the amount of $925,730) are included
in Intangible assets, net on the Company’s Consolidated Balance Sheets. All previous license agreements between NRC and
the Company were terminated as a condition of the Purchase Agreement. NRC has a security interest in these patent rights acquired
by the Company from NRC until the note payable has been satisfied.
NOTE 11. - SEVERANCE LIABILITY
The Company recorded an accrual
for severance during the fourth quarter of 2014 in the initial amount of $624,320 in accordance with FASB ASC 712 - “Compensation
- Nonretirement Postemployment Benefits.” The severance accrual relates to the October 25, 2014 termination of Joseph Pandolfino,
the Company’s former Chairman of the Board and Chief Executive Officer. The prior Employment Agreement with Mr. Pandolfino
provided that in certain circumstances Mr. Pandolfino would receive severance payments in the gross amount of $18,750 per month,
subject to customary withholdings, over a term of 36 months. Amounts owed to Mr. Pandolfino have been discounted using the Company’s
incremental borrowing rate, resulting in current and long-term liabilities of $212,012 and $412,308, respectively, at December
31, 2014. Due to alleged breaches of the Employment Agreement by Mr. Pandolfino, payments were suspended by the Company on February
13, 2015. Resulting litigation between Mr. Pandolfino and the Company was settled on November 6, 2015, and pursuant to the settlement
agreement Mr. Pandolfino’s severance benefits were reinstated, including a catch-up payment through the date of the settlement.
As a result of the severance benefit payments made during 2016, the discounted current and long-term balance of the severance
liability amounted to $199,657 and $0, respectively, at December 31, 2016 ($220,661 and $199,658, respectively, at December 31,
2015).
NOTE 12. - WARRANT EXCHANGE PROGRAM AND WARRANTS FOR COMMON
STOCK
On December 31, 2016, the Company had
outstanding warrants to purchase 13,781,921 shares of common stock of the Company, of which only 94,721 warrants contain an anti-dilution
feature. The Crede Tranche 2 and Tranche 3 warrants are excluded from the outstanding warrant total of 13,781,921 (see Note 6 –
Joint Venture, Consulting Agreement and Associated Warrants for additional information).
On January 25, 2016, warrants to purchase
67,042 shares of common stock were exercised, primarily on a cashless basis, resulting in the issuance of 2,618 shares of the
Company’s common stock. On January 25, 2016, warrants to purchase 6,831,115 shares of common stock expired without being
exercised.
Pursuant to the registered direct offering
that closed on October 19, 2016, and discussed in Note 2, the Company issued warrants to purchase 4,250,000 shares of common stock
with an exercise price of $1.45 per share. These warrants had a term of sixty-six (66) months, were not exercisable for six months
immediately following the date of issuance, did not contain an anti-dilution feature, and had a fair value of approximately $3,380,000
at issuance.
Pursuant to the registered direct offering
that closed on July 27, 2016, and discussed in Note 3, the Company issued warrants to purchase 7,043,211 shares of common stock.
The warrants provide for an exercise price of $1.00 per share and 1,543,210 of the warrants were exercisable immediately and had
a fair value of approximately $858,000 at issuance and 5,500,001 of the warrants were exercisable six months from the date of
issuance and had a fair value of approximately $3,058,000 at issuance. All the warrants have a term of 5.5 years and do not contain
an anti-dilution feature. In addition, on July 27, 2016, the Company terminated an aggregate of 5.5 million warrants with exercise
prices of $1.21 and $1.25 per share (see also Note 4 – February 2016 Registered Direct Offering and Note 5 – June
2015 Registered Direct Offering for additional information).
Pursuant to the registered direct offering
that closed on February 5, 2016, and discussed in Note 4, the Company issued warrants to purchase 2,500,000 shares of common stock
with an exercise price of $1.21 per share. These warrants had a term of sixty-six (66) months, were not exercisable for six months
immediately following the date of issuance, did not contain an anti-dilution feature, and had a fair value of approximately $1,940,000
at issuance. The warrants associated with this transaction were terminated on July 27, 2016 (see Note 3 – July 2016 Registered
Direct Offering for additional information).
Pursuant to the registered direct offering
that closed on June 2, 2015, and discussed in Note 5, the Company issued warrants to purchase 3,000,000 shares of common stock
with an exercise price of $1.25 per share. These warrants had a term of sixty-six (66) months, were not exercisable for six months
immediately following the date of issuance, did not contain an anti-dilution feature, and had a fair value of approximately $2,067,000
at issuance. The warrants associated with this transaction were terminated on July 27, 2016 (see Note 3 – July 2016 Registered
Direct Offering for additional information).
Outstanding
warrants
at
December
31
,
2016
consist
of
the
following
:
Warrant Description
|
|
Number of
Warrants
|
|
|
Exercise
Price
|
|
|
Expiration
|
|
|
|
|
|
|
|
|
|
December 2011 convertible NP warrants
|
|
|
172,730
|
|
|
$
|
1.1984
|
|
|
February 8, 2017
|
December 2011 convertible NP warrants
|
|
|
802,215
|
|
|
$
|
1.3816
|
|
|
February 6, 2018
|
May 2012 PPO warrants
|
|
|
401,700
|
|
|
$
|
0.6000
|
|
|
May 15, 2017
|
November 2012 PPO warrants
|
|
|
925,100
|
|
|
$
|
0.6000
|
|
|
November 9, 2017
|
August 2012 convertible NP warrants
(1)
|
|
|
94,721
|
|
|
$
|
0.9310
|
|
|
August 8, 2018
|
August 2012 convertible NP warrants
|
|
|
92,244
|
|
|
$
|
0.9060
|
|
|
August 8, 2018
|
July 2016 registered direct offering warrants
|
|
|
7,043,211
|
|
|
$
|
1.0000
|
|
|
January 27, 2021
|
October 2016 registered direct offering warrants
|
|
|
4,250,000
|
|
|
$
|
1.4500
|
|
|
April 19, 2022
|
|
|
|
|
|
|
|
|
|
|
|
Total warrants outstanding
(2), (3)
|
|
|
13,781,921
|
|
|
|
|
|
|
|
|
(1)
|
Includes
anti-dilution features.
|
|
(2)
|
Includes warrants
to purchase 533,000 shares of common stock (3.9%) held by officers and directors that
have had the anti-dilution feature removed.
|
|
(3)
|
Includes
warrants to purchase 312,730 shares of common stock (2.3%) held by a former officer and
director that have had the anti- dilution feature removed.
|
The Company estimates the value of
warrant liability upon issuance of the warrants and at each balance sheet date using the binomial lattice model to allocate total
enterprise value to the warrants and other securities in the Company’s capital structure. Volatility was estimated based
on historical observed equity volatilities and implied (forward) or expected volatilities for a sample group of guideline companies
and consideration of recent market trends.
As a result of the previously
exercisable exchange rights contained in the Tranche 1A warrants, the financial instrument was previously considered a
liability in accordance with FASB Accounting Standards Codification Topic 480 - “Distinguishing Liabilities from
Equity” (“ASC 480”). More specifically, ASC 480 requires a financial instrument to be classified as a
liability if such financial instrument contains a conditional obligation that the issuer must or may settle by issuing a
variable number of its equity securities if, at inception, the monetary value of the obligation is based on a known fixed
monetary amount. As a result of the actions by Crede that caused the exchange rights feature to be voided (see Note 6 - Joint
Venture, Consulting Agreement and Associated Warrants for additional information), the Company reclassified the Tranche 1A
warrant liability to Capital in excess of par. The Tranche 1A warrant expired in September 2016 unexercised.
The following table is a roll-forward summary of the
warrant liability:
Fair value at December 31, 2013
|
|
$
|
3,779,522
|
|
Reclassification of warrant liability to equity resulting from Warrant Amendments - Q1 2014
|
|
|
(7,367,915
|
)
|
Cost of inducement from Warrant Amendments - Q1 2014
|
|
|
144,548
|
|
Fair value of warrant liability resulting from issuance of Crede Tranche 1A Warrants - Q3 2014
|
|
|
2,810,000
|
|
Loss as a result of change in fair value
|
|
|
3,676,691
|
|
Fair value at December 31, 2014
|
|
$
|
3,042,846
|
|
Gain as a result of change in fair value
|
|
|
(144,550
|
)
|
Fair value at December 31, 2015
|
|
$
|
2,898,296
|
|
Reclassification of warrant liability to capital in excess of par
|
|
|
(2,810,000
|
)
|
Gain as a result of change in fair value
|
|
|
(29,615
|
)
|
Fair value at December 31, 2016
|
|
$
|
58,681
|
|
The aggregate net gain (loss) as a
result of the Company’s warrant liability for the years ended December 31, 2016, 2015 and 2014 amounted to $29,615, $144,500
and ($3,676,691), respectively, which are included in Other income (expense) under Warrant liability gain (loss) - net in the
accompanying Consolidated Statements of Operations.
FASB ASC 820 - “Fair Value
Measurements and Disclosures” establishes a valuation hierarchy for disclosure of the inputs to valuation used to measure
fair value. This hierarchy prioritizes the inputs into three broad levels as follows:
|
·
|
Level 1 inputs
are quoted prices (unadjusted) in active markets for identical assets or liabilities;
|
|
·
|
Level 2 inputs
are quoted prices for similar assets and liabilities in active markets or inputs that
are observable for the asset or liability, either directly or indirectly through market
corroboration, for substantially the full term of the financial instrument; and
|
|
·
|
Level 3 inputs
are unobservable inputs based on the Company’s own assumptions used to measure
assets and liabilities at fair value.
|
A financial asset’s or a financial
liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the
fair value measurement. The warrant liability is measured at fair value using certain estimated factors such as volatility and
probability which are classified within Level 3 of the valuation hierarchy. Significant unobservable inputs that are used in the
fair value measurement of the Company’s derivative warrant liabilities include volatility. Significant increases (decreases)
in the volatility input would result in a significantly higher (lower) fair value measurement.
The following table summarizes the
Company’s warrant activity since December 31, 2013:
|
|
Number
of
Warrants
|
|
Warrants outstanding at December 31, 2013
|
|
|
10,653,469
|
|
Warrants issued in conjunction with consulting agreement
|
|
|
4,250,000
|
|
Warrants exercised during 2014
|
|
|
(1,247,443
|
)
|
Additional warrants due to anti-dilution provisions
|
|
|
18,383
|
|
Warrants outstanding at December 31, 2014
|
|
|
13,674,409
|
|
Warrants issued in conjunction with registered direct offering
|
|
|
3,000,000
|
|
Warrants exercised during 2015
|
|
|
(40,000
|
)
|
Additional warrants due to anti-dilution provisions
|
|
|
369
|
|
Warrants outstanding at December 31, 2015
|
|
|
16,634,778
|
|
Warrants issued in conjunction with registered direct offering
|
|
|
2,500,000
|
|
Unexercisable warrants
(1)
|
|
|
(2,000,000
|
)
|
Warrants exercised during January 2016
|
|
|
(67,042
|
)
|
Warrants expired during January 2016
|
|
|
(6,831,115
|
)
|
June 2015 registered direct offering warrants cancelled
|
|
|
(3,000,000
|
)
|
February 2016 registered direct offering warrants cancelled
|
|
|
(2,500,000
|
)
|
Warrants issued in conjunction with July 2016 registered direct offering
|
|
|
7,043,211
|
|
Additional warrants due to anti-dilution provisions
|
|
|
2,089
|
|
Warrants expired during September 2016
(2)
|
|
|
(2,250,000
|
)
|
Warrants issued in conjunction with October 2016 registered direct offering
|
|
|
4,250,000
|
|
Warrants outstanding at December 31, 2016
|
|
|
13,781,921
|
|
|
|
|
|
|
Composition of outstanding warrants:
|
|
|
|
|
Warrants containing anti-dilution feature
|
|
|
94,721
|
|
Warrants without anti-dilution feature
|
|
|
13,687,200
|
|
|
|
|
13,781,921
|
|
|
(1)
|
Crede Tranche 2
Warrants and Tranche 3 Warrants are not exercisable (see Note 6 for additional information).
|
|
(2)
|
Crede Tranche 1A
Warrants and Crede Tranche 1B Warrants expired unexercised on September 29, 2016.
|
NOTE 13. - RETIREMENT PLAN
The Company sponsors a defined contribution
plan under IRC Section 401(k). The plan covers all employees who meet the minimum eligibility requirements. Under
the 401(k) plan eligible employees are allowed to make voluntary deferred salary contribution to the plan, subject to statutory
limits. The Company has elected to make Safe Harbor Non-elective Contributions to the plan for eligible employees in the
amount of three percent (3%) of the employee’s compensation. Total employer contributions to the plan for the years
ended December 31, 2016, 2015 and 2014 amounted to $84,499, $56,208 and $27,485, respectively.
NOTE 14. - COMMITMENTS AND CONTINGENCIES
License Agreements -
Under its
exclusive worldwide license agreement with North Carolina State University (“NCSU”), the Company is required to pay
minimum annual royalty payments, which are credited against running royalties on sales of licensed products. The minimum annual
royalty for 2015 was $75,000 and in 2016 the minimum annual royalty increased to $225,000. The license agreement continues through
the life of the last-to-expire patent, which is expected to be 2022. The license agreement also requires a milestone payment of
$150,000 upon FDA approval or clearance of a product that uses the NCSU licensed technology. The Company is also responsible for
reimbursing NCSU for actual third-party patent costs incurred. These costs vary from year to year and the Company has certain
rights to direct the activities that result in these costs. During the years ended December 31, 2016, 2015 and 2014 the aggregate
costs incurred related to capitalized patent costs and patent maintenance expense amounted to $84,191, $103,641 and $122,879,
respectively.
On December 8, 2015, the Company entered into
an additional license agreement (the “License”) with NCSU. Under the terms of the License, the Company paid NCSU a
non-refundable, non-creditable lump sum license fee of $150,000. Additionally, the License calls for the Company to pay NCSU a
non-refundable, non-creditable minimum annual royalties beginning on December 31, 2018 in the amount of $10,000. The minimum annual
royalty payment increases to $15,000 in 2019, $25,000 in 2020 and 2021, and $50,000 per year thereafter for the remaining term
of the License. The Company is also responsible for reimbursing NCSU for actual third-party patent costs incurred. During the
years ended December 31, 2016 and 2015, the aggregate costs incurred related to capitalized patent costs and patent maintenance
expense amounted to $6,075 and $0, respectively. This License continues through the life of the last-to-expire patent, expected
to be in 2036.
On February 10, 2014, the Company entered
into a sponsored research and development agreement (the “Agreement”) with NCSU. Under the terms of the
Agreement, the Company paid NCSU $162,408 over the two-year term of the Agreement, which grants certain licensed rights to
the Company. The Company has extended the Agreement through January 31, 2017 at an additional cost of $85,681. The Company
plans to extend and amend its Agreement in 2017 with NCSU relating to very low nicotine tobacco plants.
All payments made under the above referenced
license agreement and the sponsored research and development agreement are initially recorded as a Prepaid expense on the Company’s
Consolidated Balance Sheets and subsequently expensed on a straight-line basis over the applicable period and included in Research
and development costs on the Company’s Consolidated Statements of Operations. The amounts expensed during the years ended
December 31, 2016, 2015 and 2014 were $447,808, $156,204 and $149,437, respectively.
On August 22, 2014, the Company entered into
a Commercial License Agreement with Precision PlantSciences, Inc. (the “Precision License”). The Precision License
grants the Company a non-exclusive, but fully paid up right and license to use technology and materials owned by Precision PlantSciences,
Inc. for a license fee of $1,250,000. An initial cash payment of $725,000 was made upon execution of the Precision License with
an unconditional obligation to pay the remaining $525,000 in $25,000 increments as materials are provided to the Company. The
remaining $525,000 was paid during December 2014. The Precision License continues through the life of the last-to-expire patent,
which is expected to be in 2028.
On August 27, 2014, the Company entered into
an additional exclusive License Agreement (the “License Agreement”) with NCSU. Under the License Agreement, the Company
paid NCSU a non-refundable, non-creditable lump sum license fee of $125,000. Additionally, the License Agreement calls for the
Company to pay NCSU three non-refundable, non-creditable license maintenance fees in the amount of $15,000 per annum in each of
December 2015, 2016 and 2017. Beginning in calendar year 2018, the Company is obligated to pay to NCSU an annual minimum royalty
fee of $20,000 in 2018, $30,000 in 2019, and $50,000 per year thereafter for the remaining term of the License Agreement. The
Company is also responsible for reimbursing NCSU for actual third-party patent costs incurred. During the years ended December
31, 2016, 2015 and 2014, the aggregated costs incurred related to capitalized patent costs and patent maintenance expense amounted
to $43,740, $75,351 and $1,089, respectively. The License Agreement continues through the life of the last-to-expire patent, which is expected
to be in 2034.
On September 15, 2014, the Company entered
into a Sublicense Agreement with Anandia Laboratories, Inc. (the “Anandia Sublicense”). Under the terms of the Anandia
Sublicense, the Company was granted an exclusive sublicense in the United States and a co-exclusive sublicense in the remainder
of the world, excluding Canada, to the licensed Intellectual Property (more fully discussed in Note 9). The Anandia Sublicense
calls for an up-front fee of $75,000, an annual license fee of $10,000, the payment of patent filing and maintenance costs, and
a running royalty on future net sales. The Anandia Sublicense continues through the life of the last-to-expire patent, which is
expected to be in 2035.
The Precision License, the License
Agreement with NCSU and the Anandia Sublicense are included in Intangible assets, net in the Company’s Consolidated
Balance Sheets and the applicable license fees will be amortized over the term of the agreements based on their
last-to-expire patent date. Amortization expense during the years ended December 31, 2016, 2015 and 2014 amounted to $98,022,
$98,022 and $32,524, respectively, and was included in Research and development costs on the Company’s Consolidated
Statements of Operations.
On September 28, 2015, the Company’s
wholly-owned subsidiary, Botanical Genetics, entered into a Sponsored Research Agreement (the “Agreement”) with
Anandia Laboratories Inc. (“Anandia”). Pursuant to the Agreement, Anandia will conduct research on behalf of the
Company relating to the cannabis plant. The Agreement has an initial term of twelve (12) months from the date of the
Agreement and can be extended at the sole option of the Company for two (2) additional periods of twelve (12) months each.
The Company is currently in negotiations to exercise the first extension option that contains a potential annual budget
of approximately $785,000. The Company has paid Anandia $379,800 over the initial term of the Agreement. During the
years ended December 31, 2016 and 2015 expenses related to the Agreement amounted to $263,400 and $116,400, respectively, and
are included in Research and development costs on the Company’s Consolidated Statements of Operations. Under the terms
of the Agreement, the Company will have co-exclusive worldwide rights with Anandia to all the intellectual property resulting
from the sponsored research between the Company and Anandia. The party that commercializes such intellectual property in the
future will pay royalties in varying amounts to the other party, with the amount of such royalties being dependent upon the
type of products that are commercialized in the future. If either party sublicenses such intellectual property to a
third-party, then the Company and Anandia will share equally in such sublicensing consideration.
The Company had an R&D
agreement with the University of Virginia (“UVA”) relating to nicotine biosynthesis in tobacco plants. The
extended term of the R&D agreement with UVA expired on October 31, 2016. The Company incurred R&D expenses under the
agreement in the amount $224,560, $224,428 and $222,862 for the years ended December 31, 2016, 2015 and 2014, respectively.
In December 2016, the Company entered into a new sponsored research agreement with UVA and an exclusive license agreement
with the University of Virginia Patent Foundation d/b/a University of Virginia Licensing & Ventures Group (“UVA
LVG”) pursuant to which we will invest approximately $1,000,000 over a three-year period with UVA to create unique
industrial hemp plants with guaranteed levels of THC below the legal limits and optimize other desirable hemp plant
characteristics to improve the plant’s suitability for growing in Virginia and other legacy tobacco regions. This work
with UVA will also involve the development and study of medically important cannabinoids to be extracted by UVA from the
Company’s unique hemp plants. UVA and the Company will conduct all activities in this scientific collaboration within
the parameters of state and federal licenses and permits held by UVA for such work. The new agreements with UVA and UVA LVG
grant the Company exclusive rights to commercialize all results of the collaboration in consideration of royalty payments by
the Company to UVA LVG.
Lease
Agreements
-
The Company leases a manufacturing facility and warehouse
located in North Carolina on a triple net lease basis. The lease commenced on January 14, 2014, and had an initial term of
twelve (12) months. The lease contains four (4) additional extensions; with one lease extension being for an additional one
(1) year and with the other three (3) lease extensions each being for an additional two (2) years in duration, exercisable at
the option of the Company. The Company is currently in the first two-year lease extension term that will expire on October
31, 2017. The lease expense for the years ended December 31, 2016, 2015 and 2014 amounted to approximately $146,000, $127,000
and $98,000, respectively. The future minimum lease payments if the Company exercises each of the additional extensions are
approximately as follows:
Year ended December 31, 2017 -
|
|
$
|
156,000
|
|
Year ended December 31, 2018 -
|
|
$
|
169,000
|
|
Year ended December 31, 2019 -
|
|
$
|
169,000
|
|
Year ended December 31, 2020 -
|
|
$
|
169,000
|
|
Year ended December 31, 2021 -
|
|
$
|
141,000
|
|
The Company has a lease for its office
space in Clarence, New York and extended the lease for an additional one-year renewal period expiring on August 31, 2017. Future
minimum lease payments for the year ended December 31, 2017 are approximately $31,000.
On November 1, 2015, the Company
entered into a one-year lease for 25,000 square feet of warehouse space in North Carolina to store the Company’s
proprietary tobacco leaf. The lease calls for a monthly lease payment of $3,750 and contains a three-year renewal option
after the initial one-year term. In October of 2016, the Company exercised the three-year renewal option after the one-year
term. Future minimum lease payments for the years ended December 31, 2017, 2018 and 2019 are $45,000, $45,000 and $37,500,
respectively, if the Company exercises the optional renewal period.
On May 1, 2016, the Company entered
into a sublease for laboratory space in Buffalo, New York. The sublease calls for a monthly payment of $1,471, expires on April
30, 2017 and contains an option to extend the lease for a period of one year through April 30, 2018. Future minimum sublease payments
for the years ended December 31, 2017 and 2018 are approximately $18,000 and $6,000, respectively, if the Company exercises the
optional renewal period.
On September 1, 2016, the Company entered
into a sublease for warehouse space in North Carolina to store and operate tobacco leaf processing equipment. The sublease calls
for a monthly payment of $1,200, expires on August 31, 2017 and contains twelve-month renewal options as long as the sublessor
continues to sublease the warehouse. Future minimum sublease payments for the year ended December 31, 2017 are $14,400 per year
for each subsequent year the warehouse space is sublet by the Company.
Litigation
- In
accordance with applicable accounting guidance, the Company establishes an accrued liability for litigation and regulatory matters
when those matters present loss contingencies that are both probable and estimable. In such cases, there may be an exposure to
loss in excess of any amounts accrued. When a loss contingency is not both probable and estimable, the Company does not establish
an accrued liability. As a litigation or regulatory matter develops, the Company, in conjunction with any outside counsel handling
the matter, evaluates on an ongoing basis whether such matter presents a loss contingency that is probable and estimable. If,
at the time of evaluation, the loss contingency related to a litigation or regulatory matter is not both probable and estimable,
the matter will continue to be monitored for further developments that would make such loss contingency both probable and estimable.
When a loss contingency related to a litigation or regulatory matter is deemed to be both probable and estimable, the Company
will establish an accrued liability with respect to such loss contingency and record a corresponding amount of litigation-related
expense. The Company will then continue to monitor the matter for further developments that could affect the amount of any such
accrued liability.
On April 26, 2016, Crede CG III, LTD. (“Crede”)
filed a complaint against the Company in the United States District Court for the Southern District of New York (the “SDNY
Court”) entitled
Crede CG III, LTD. v. 22nd Century Group, Inc
. On May 19, 2016, Crede filed an Amended
Complaint that includes seven counts, alleging among other things, that the Company allegedly breached and/or interfered with certain
agreements entered into with Crede, including the joint venture agreement relating to efforts to sell the Company’s proprietary
tobacco into China, the Tranche 1A warrant and the prior securities purchase agreement with Crede. The Amended Complaint
seeks money damages, to rescind the securities purchase agreement, to obtain declaratory and injunctive relief to require the Company
to issue to Crede 2,077,555 shares of the Company’s common stock under the exchange provision of the Tranche 1A warrant,
and entry of an injunction prohibiting the Company from selling tobacco into China without the joint venture’s involvement.
The Amended Complaint also seeks attorney’s fees and such other relief as the Court may deem just and proper. We believe
that the claims are frivolous, meritless and that the Company has substantial legal and factual defenses to the claims.
On May 19, 2016, Crede filed a motion for preliminary
injunction, asking the SDNY Court to require the Company to issue 2,077,555 shares of its common stock to Crede under the exchange
provision of the Tranche 1A warrant. After conducting an evidentiary hearing on this motion on June 14, 2016, the SDNY Court
denied Crede’s motion and held, among other things, that Crede did not prove the potential for irreparable harm or a likelihood
of success on its claim for such 2,077,555 shares under the Tranche 1A warrant, and that there was a likelihood that Crede had
violated the activity restrictions of the Tranche 1A warrant, which would bar Crede’s claim for such shares from the Company.
Following such ruling, on July 11, 2016, the Company
filed a motion to sever the Crede lawsuit into two separate cases, requesting all claims relating to the Tranche 1A warrant and
the securities purchase agreement to stay in the SDNY Court and all claims relating to the China joint venture agreement to be
transferred to the United States District Court for the Western District of New York (the “WDNY Court”), where the
Company’s headquarters are located. On January 20, 2017, the SDNY Court granted the Company’s motion.
On February 14, 2017, Crede voluntarily dismissed
its lawsuit against the Company in the WDNY Court.
On February 21, 2017, the SDNY Court granted the
Company’s request to file a motion for summary judgment for the claims remaining in the SDNY Court, with all discovery in
the case being deferred until after the SDNY Court conducts a hearing and issues its decision on the summary judgment motion to
be filed by the Company.
We
believe that the claims are frivolous, meritless and that the Company has substantial legal and factual defenses to the claims.
The Company has defended and intends to continue to defend against these claims vigorously.
NOTE 15. - EARNINGS PER COMMON SHARE
The following table sets forth the
computation of basic and diluted earnings per common share for the years ended December 31, 2016, 2015 and 2014:
|
|
December 31,
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
|
|
|
|
|
|
|
|
|
|
Net loss attributed to common shareholders
|
|
$
|
(11,581,430
|
)
|
|
$
|
(11,031,931
|
)
|
|
$
|
(15,595,358
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for basic earnings per share-weighted average shares outstanding
|
|
|
79,842,773
|
|
|
|
68,143,284
|
|
|
|
59,993,413
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrants, restricted stock and options outstanding
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for diluted earnings per common share-weighted average shares
adjusted for dilutive securities
|
|
|
79,842,773
|
|
|
|
68,143,284
|
|
|
|
59,993,413
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss per common share - basic and diluted
|
|
$
|
(0.15
|
)
|
|
$
|
(0.16
|
)
|
|
$
|
(0.26
|
)
|
Securities outstanding
that were excluded from the computation of earnings per share for the years ended December 31, 2016, 2015 and 2014 because they
would have been anti-dilutive are as follows:
|
|
December 31,
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
Warrants
|
|
|
13,781,921
|
|
|
|
16,634,778
|
|
|
|
13,674,409
|
|
Restricted stock
|
|
|
-
|
|
|
|
-
|
|
|
|
250,000
|
|
Options
|
|
|
5,650,679
|
|
|
|
3,161,642
|
|
|
|
890,000
|
|
|
|
|
19,432,600
|
|
|
|
19,796,420
|
|
|
|
14,814,409
|
|
NOTE 16. - EQUITY BASED COMPENSATION
On October 21, 2010, the Company established
the 2010 Equity Incentive Plan (“EIP”) for officers, employees, directors, consultants and advisors to the Company
and its affiliates, which consisted of 4,250,000 shares of common stock. During the first quarter of 2014, the Company issued
restricted stock awards from the EIP for 850,000 restricted shares to employees and directors that vested on January 27, 2015.
All awards were valued at the closing price of the Company’s common stock on the measurement date of the award. No additional
awards are issuable under the EIP.
On April 12, 2014, the stockholders
of the Company approved the 22nd Century Group, Inc. 2014 Omnibus Incentive Plan (the “OIP”). The OIP allows for the
granting of equity and cash incentive awards to eligible individuals over the life of the OIP, including the issuance of up to
5,000,000 shares of the Company’s common stock pursuant to awards under the OIP. The OIP has a term of ten years and is
administered by the Compensation Committee of the Company’s Board of Directors to determine the various types of incentive
awards that may be granted to recipients under this plan and the number of shares of common stock to underlie each such award
under the OIP.
During the year ended December 31,
2016, the Company issued stock option awards from the OIP for 2,389,037 shares to eligible individuals having vesting periods
ranging from six months to three and one-half years from the date of the award. During the year ended December 31, 2015, the Company
issued stock option awards from the OIP for 1,821,642 shares and restricted stock option awards from the OIP for 20,000 shares
to eligible individuals having vesting periods ranging from six months to one year from the date of the awards. All stock option
awards were valued using the Black-Scholes option-pricing model on the date of the award, and all restricted stock awards were
valued at the closing price of the Company’s common stock on the NYSE MKT on the date of the award.
For the years ended December 31, 2016,
2015 and 2014, the Company recorded compensation expense related to restricted stock and stock option awards granted under the
EIP and OIP of $880,509, $1,326,393 and $2,293,082, respectively. During the year ended December 31, 2016, the Company issued
stock to third-party service providers in the amount of 15,811 shares and issued stock options in the amount of 100,000 shares
to a third-party service provider. During the year ended December 31, 2015, the Company issued restricted stock to third-party
service providers in the amount of 279,196 shares and issued stock options to third-party service providers in the amount of 400,000
shares. The Company recorded equity based compensation expense related to the third-party providers for the years ended December
31, 2016, 2015 and 2014 in the amount of $30,873, $280,362 and $140,170, respectively, and does not include equity based compensation under the Crede Consulting Agreement in the amount of
$0, $1,978,785 and $2,091,215 for the years ended December 31, 2016, 2015 and 2014,
respectively.
As of December 31, 2016, unrecognized
compensation expense related to non-vested restricted shares and stock options amounted to approximately $1,383,000 which is expected
to be recognized approximately as follows: $447,000, $357,000 and $112,000 during 2017, 2018 and 2019, respectively. Approximately
$467,000 of the unrecognized compensation expense relates to previously issued stock options, with the vesting of such stock options
being based on the achievement of a certain milestone, and the attainment of such milestone cannot be determined at this time.
The fair value of each option grant
is estimated on the date of grant using the Black-Scholes option-pricing model. The following assumptions were used for the years
ended December 31 2016, 2015 and 2014:
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
Risk-free interest rate (weighted average)
|
|
|
1.31
|
%
|
|
|
1.60
|
%
|
|
|
1.80
|
%
|
Expected dividend yield
|
|
|
0
|
%
|
|
|
0
|
%
|
|
|
0
|
%
|
Expected stock price volatility
|
|
|
90
|
%
|
|
|
90
|
%
|
|
|
90
|
%
|
Expected life of options (weighted average)
|
|
|
4.87
years
|
|
|
|
8.96
years
|
|
|
|
10
years
|
|
The Company estimated the expected
volatility based on data used by a peer group of public companies. The expected term was estimated using the contract life of
the option. The risk-free interest rate assumption was determined using yield of the equivalent U.S. Treasury bonds over the expected
term. The Company has never paid any cash dividends and does not anticipate paying any cash dividends in the foreseeable future.
Therefore, the Company assumed an expected dividend yield of zero.
A summary of all stock option activity
since December 31, 2013 is as follows:
|
|
|
|
|
Weighted
|
|
|
Weighted
Average
Remaining
|
|
Aggregate
|
|
|
|
Number
of
Options
|
|
|
Average
Exercise
Price
|
|
|
Contractual
Term
|
|
Intrinsic
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2013
|
|
|
660,000
|
|
|
$
|
0.74
|
|
|
|
|
|
|
|
Granted in 2014
|
|
|
300,000
|
|
|
$
|
2.61
|
|
|
|
|
|
|
|
Exercised in 2014
|
|
|
(70,000
|
)
|
|
$
|
0.69
|
|
|
|
|
|
|
|
Outstanding at December 31, 2014
|
|
|
890,000
|
|
|
$
|
1.38
|
|
|
|
|
|
|
|
Reinstated in 2015
|
|
|
50,000
|
|
|
$
|
0.69
|
|
|
|
|
|
|
|
Granted in 2015
|
|
|
2,221,642
|
|
|
$
|
1.00
|
|
|
|
|
|
|
|
Outstanding at December 31, 2015
|
|
|
3,161,642
|
|
|
$
|
1.10
|
|
|
|
|
|
|
|
Granted in 2016
|
|
|
2,489,037
|
|
|
$
|
0.97
|
|
|
|
|
|
|
|
Outstanding at December 31, 2016
|
|
|
5,650,679
|
|
|
$
|
1.04
|
|
|
7.4 years
|
|
$
|
875,845
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at December 31, 2016
|
|
|
2,711,642
|
|
|
$
|
1.07
|
|
|
6.8 years
|
|
$
|
433,380
|
|
There were stock options
granted during the years ended December 31, 2016, 2015 and 2014, to purchase a total of 2,489,037, 2,221,642 and 300,000
shares, respectively. The weighted average grant date fair value of options issued during the years ended December 31, 2016,
2015 and 2014 was $0.66, $0.58 and $2.07, respectively. The total fair value of options that vested during years ended
December 31, 2016, 2015, and 2014 amounted to $1,242,110, $206,500 and $103,250, respectively. During the year ended
December 31, 2014, 70,000 options were exercised for cash proceeds of $48,300. No options were exercised during the years
ended December 31, 2016 and 2015.
NOTE 17. - INCOME TAXES
The following is a summary of the components
giving rise to the income tax provision (benefit) for the years ended December 31, 2016, 2015 and 2014.
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
|
|
|
|
|
|
|
|
|
|
Current:
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
State
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Total current
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred:
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
|
(2,424,497
|
)
|
|
|
(3,372,964
|
)
|
|
|
(3,494,787
|
)
|
State
|
|
|
21,452
|
|
|
|
(155,352
|
)
|
|
|
160,319
|
|
Total deferred
|
|
|
(2,403,045
|
)
|
|
|
(3,528,316
|
)
|
|
|
(3,334,468
|
)
|
Change in valuation allowance
|
|
|
2,403,045
|
|
|
|
3,528,316
|
|
|
|
3,334,468
|
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
The provision (benefit) for income tax varies
from that which would be expected based on applying the statutory federal rate to pre-tax accounting loss as follows:
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
|
|
|
|
|
|
|
|
|
|
Statutory federal rate
|
|
|
(34.0
|
)%
|
|
|
(34.0
|
)%
|
|
|
(34.0
|
)%
|
Other items
|
|
|
(0.2
|
)
|
|
|
0.0
|
|
|
|
0.6
|
|
Derivative liability
|
|
|
11.9
|
|
|
|
(0.5
|
)
|
|
|
8.4
|
|
Stock based compensation
|
|
|
1.5
|
|
|
|
3.1
|
|
|
|
2.5
|
|
State tax provision, net of federal benefit
|
|
|
0.1
|
|
|
|
(0.9
|
)
|
|
|
1.1
|
|
Valuation allowance
|
|
|
20.7
|
|
|
|
32.3
|
|
|
|
21.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effective tax rate (benefit) provision
|
|
|
0.0
|
%
|
|
|
0.0
|
%
|
|
|
0.0
|
%
|
Individual components of deferred taxes consist
of the following as of December 31:
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
|
|
|
|
|
|
|
|
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net operating loss carry-forward
|
|
$
|
11,626,143
|
|
|
$
|
7,745,734
|
|
|
$
|
4,775,536
|
|
Accounts receivable reserve
|
|
|
3,499
|
|
|
|
3,499
|
|
|
|
-
|
|
Inventory
|
|
|
96,934
|
|
|
|
38,707
|
|
|
|
17,713
|
|
Stock-based compensation
|
|
|
282,850
|
|
|
|
1,599,916
|
|
|
|
809,319
|
|
Start-up expenditures
|
|
|
477,917
|
|
|
|
514,680
|
|
|
|
388,130
|
|
Loss on equity investment
|
|
|
139,676
|
|
|
|
68,877
|
|
|
|
35,398
|
|
Severance liability
|
|
|
69,860
|
|
|
|
147,070
|
|
|
|
218,450
|
|
Other
|
|
|
21,423
|
|
|
|
9,272
|
|
|
|
6,561
|
|
|
|
|
12,718,302
|
|
|
|
10,127,755
|
|
|
|
6,251,107
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed assets
|
|
|
(316,232
|
)
|
|
|
(227,186
|
)
|
|
|
(80,251
|
)
|
Patents and trademarks
|
|
|
(807,137
|
)
|
|
|
(767,044
|
)
|
|
|
(624,010
|
)
|
Other intangible assets
|
|
|
(138,713
|
)
|
|
|
(80,349
|
)
|
|
|
(21,986
|
)
|
|
|
|
(1,262,082
|
)
|
|
|
(1,074,579
|
)
|
|
|
(726,247
|
)
|
Valuation allowance
|
|
|
(11,456,220
|
)
|
|
|
(9,053,176
|
)
|
|
|
(5,524,860
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net deferred taxes
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
The Company has incurred a net operating loss
(“NOL”) of approximately $33,700,000 through December 31, 2016 and this amount is being carried forward to future
years and begins to expire in 2031. Due to the uncertainty of the Company’s ability to generate sufficient taxable income
in the future before they expire, the company has recorded a valuation allowance to reduce the net deferred tax asset to zero.
This NOL is included in the net deferred tax asset that has been fully offset by the valuation allowance. Utilization of the NOL
carryforwards may be subject to an annual limitation (or the NOL’s may expire unutilized) in the case of equity ownership
changes, as defined by tax law.
ASC 740 provides guidance on the financial
statement recognition and measurement for uncertain income tax positions that are taken or expected to be taken in a company’s
income tax return. The Company has no uncertain tax positions as of December 31, 2016.
NOTE 18. - SELECTED QUARTERLY FINANCIAL DATA (unaudited)
Below is selected quarterly financial data
for the years ended December 31, 2016 and 2015:
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
June 30,
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2016
|
|
|
2016
|
|
|
2016
|
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue, net
|
|
$
|
3,019,056
|
|
|
$
|
2,827,658
|
|
|
$
|
3,097,648
|
|
|
$
|
3,335,617
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross (loss) profit
|
|
$
|
123,646
|
|
|
$
|
(140,913
|
)
|
|
$
|
(184,618
|
)
|
|
$
|
(227,814
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
$
|
(3,228,404
|
)
|
|
$
|
(2,830,830
|
)
|
|
$
|
(2,595,812
|
)
|
|
$
|
(2,732,801
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(3,252,452
|
)
|
|
$
|
(2,902,354
|
)
|
|
$
|
(2,679,988
|
)
|
|
$
|
(2,746,636
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss per common share - basic and diluted
|
|
$
|
(0.04
|
)
|
|
$
|
(0.04
|
)
|
|
$
|
(0.03
|
)
|
|
$
|
(0.03
|
)
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
June 30,
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2015
|
|
|
2015
|
|
|
2015
|
|
|
2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue, net
|
|
$
|
616,138
|
|
|
$
|
2,306,953
|
|
|
$
|
2,667,506
|
|
|
$
|
2,931,401
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross (loss) profit
|
|
$
|
(16,442
|
)
|
|
$
|
(293,493
|
)
|
|
$
|
(281,422
|
)
|
|
$
|
10,795
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
$
|
(4,119,463
|
)
|
|
$
|
(2,346,736
|
)
|
|
$
|
(2,747,501
|
)
|
|
$
|
(2,830,183
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(4,116,739
|
)
|
|
$
|
(1,288,703
|
)
|
|
$
|
(2,761,691
|
)
|
|
$
|
(2,864,798
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss per common share - basic and diluted
|
|
$
|
(0.06
|
)
|
|
$
|
(0.02
|
)
|
|
$
|
(0.04
|
)
|
|
$
|
(0.04
|
)
|
NOTE 19. - SUBSEQUENT EVENTS
The Company’s Form S-3, universal
shelf registration statement, was filed with the U.S. Securities and Exchange Commission (“SEC”) on December 30,
2016, and became effective on January 17, 2017. The universal shelf registration statement will allow, but not compel, the
Company to raise up to $100 million of capital over a three-year period ending January 17, 2020 through a wide array of
securities at times and in amounts to be determined by the Company.
On January 20, 2017, the United States District
Court for the Southern District of New York (the “SDNY Court”) granted the Company’s motion to sever the Crede
lawsuit into two separate cases, requesting all claims relating to the Tranche 1A warrant and the securities purchase agreement
to stay in the SDNY Court and all claims relating to the China joint venture agreement to be transferred to the United States District
Court for the Western District of New York (the “WDNY Court”), where the Company’s headquarters are located.
Additionally, on February 14, 2017, Crede voluntarily dismissed its lawsuit against the Company in the WDNY Court, determining
not to pursue its claims against the Company related to the terminated China joint venture. Also, on February 21, 2017, the SDNY
Court granted the Company’s request to file a motion for summary judgment for the claims remaining in the SDNY Court, with
all discovery in the case being deferred until after the SDNY Court conducts a hearing and issues its decision on the summary judgment
motion to be filed by the Company. Please see the Litigation section of Note 14 – Commitments and Contingencies for a detailed
discussion of the Crede lawsuit.
In reviewing the agreements included as exhibits
to this report, please remember they are included to provide you with information regarding their terms and are not intended to
provide any other factual or disclosure information about the Company, its subsidiaries or other parties to the agreements. The
agreements contain representations and warranties by each of the parties to the applicable agreement. These representations and
warranties have been made solely for the benefit of the other parties to the applicable agreement and:
|
·
|
should not in all instances be treated as categorical statements of fact, but rather as a way
of allocating the risk to one of the parties if those statements prove to be inaccurate;
|
|
·
|
have been qualified by disclosures that were made to the other party in connection with the negotiation
of the applicable agreement, which disclosures are not necessarily reflected in the agreement;
|
|
·
|
may apply standards of materiality in a way that is different from what may be viewed as material to you or other investors;
and
|
|
·
|
Were made only as of the date of the applicable agreement or such other date or dates as may
be specified in the agreement and are subject to more recent developments.
|
Accordingly, these representations and warranties
may not describe the actual state of affairs as of the date they were made or at any other time. We acknowledge that, notwithstanding
the inclusion of the foregoing cautionary statements, we are responsible for considering whether additional specific disclosures
of material information regarding material contractual provisions are required to make the statements in this report not misleading.
Additional information about the Company may be found elsewhere in this report and the Company’s other public files, which
are available without charge through the SEC’s website at http://www.sec.gov.
Exhibit No. Description
2.1 Investment Agreement,
dated April 11, 2014, by and between 22nd Century Group, Inc. and Anandia Laboratories Inc. (incorporated by reference to Exhibit
2.2 to the Company’s Form 8-K filed with the Commission on September 18, 2014).
2.2 Purchase Agreement,
dated December 22, 2014, by and between 22nd Century Limited, LLC and the National Research Council of Canada (incorporated by
reference to Exhibit 2.1 to the Company’s Form 8-K filed with the Commission on December 29, 2014).
3.1 Amended and Restated
Certificate of Incorporation of the Company (incorporated herein by reference to Exhibit 3.2 of the Company’s Annual Report
on Form 10-K for the year ended September 30, 2010 filed with the Commission on December 3, 2010).
3.1.1 Amendment to
Certificate of Incorporation of the Company (incorporated by reference to Appendix A to the Company’s Definitive Proxy Statement
filed with the Commission on March 4, 2014).
3.2 Amended and Restated
Bylaws of the Company (incorporated herein by reference to Exhibit 3.2 of the Company’s Annual Report on Form 10-K for the
year ended December 31, 2014 filed with the Commission on January 30, 2014).
3.2.1 Amendment No.
1 to Amended and Restated Bylaws of the Company (incorporated herein by reference to Exhibit 3.2 of the Company’s Form 8-K
filed with the Commission on April 28, 2015).
4.1 Form of Common Stock
Purchase Warrant (incorporated herein by reference to Exhibit 4.2 of the Company’s Current Report on Form 8-K filed with
the Commission on December 14, 2011).
4.2 Form of Common
Stock Purchase Warrant (incorporated herein by reference to Exhibit 4.1 of the Company’s Current Report on Form 8-K filed
with the Commission on May 18, 2012).
4.3 Form of Common Stock Purchase Warrant (incorporated herein by reference to Exhibit
4.1 of the Company’s Current Report on Form 8-K filed with the Commission on November 13, 2012).
4.4 Form of Tranche 1A
Warrant (incorporated by reference to Exhibit 4.1 to the Company’s Form 8-K filed with the Commission on September 30, 2014).
4.5 Form of Common
Stock Purchase Warrant (incorporated by reference to Exhibit 10.2 to the Company’s Form 8-K filed with the Commission on
May 29, 2015).
4.6
Form of Common Stock Purchase Warrant (incorporated by reference to Exhibit 10.2 to the Company’s Form 8-K filed on
July 26, 2016)
4.7 Form of Common Stock Purchase Warrant (incorporated by reference to
Exhibit 10.3 to the Company’s Form 8-K filed on July 26, 2016)
4.8
Form of Common Stock Purchase Warrant (incorporated by reference to Exhibit 10.2 to the Company’s Form 8-K filed on
October 17, 2016)
10.1† 2010 Equity Incentive
Plan (incorporated herein by reference to Exhibit 4.3 to the Company’s Form S-8 filed with the Commission on March 30, 2011).
10.2† Employment Agreement
dated as of January 25, 2011, by and between the Company and Henry Sicignano III (incorporated herein by reference to Exhibit 10.16
of the Company’s Current Report on Form 8-K filed with the Commission on February 1, 2011).
10.3† Employment Agreement
dated as of March 15, 2011, by and between the Company and Michael R. Moynihan (incorporated by reference to Exhibit 10.18 to the
Company’s Form S-1 registration statement filed with the Commission on June 6, 2011).
10.4†† License
Agreement dated March 6, 2009 between North Carolina State University and 22nd Century Limited, LLC (incorporated by reference
to Exhibit 10.21 to the Company’s Form S-1 registration statement filed with the Commission on August 26, 2011).
10.4.1 Amendment dated August 9, 2012 to License
Agreement dated March 6, 2009 between North Carolina State University and 22nd Century Limited, LLC (incorporated by reference
to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Commission on August 20, 2012).
10.5†† License
Agreement dated May 1, 2009 between The National Research Council of Canada and 22nd Century Limited, LLC (incorporated by reference
to Exhibit 10.22 to the Company’s Form S-1 registration statement filed with the Commission on August 26, 2011).
10.6 Letter Agreement
between the Company and North Carolina State University dated November 22, 2011 (incorporated by reference to Exhibit 10.1 to the
Company’s Form 8-K filed with the Commission on November 23, 2011).
10.7† Employment Agreement
between John Brodfuehrer and the Company dated March 19, 2013 (incorporated by reference to Form 8-K filed on March 25, 2013).
10.8† Form of Restricted
Stock Award Agreement (incorporated by reference to Form 10-Q filed on May 10, 2013).
10.9† Form of Stock Option Award Agreement
(incorporated by reference to Form 10-Q filed on May 10, 2013).
10.10†† Research
License and Commercial Option Agreement with British American Tobacco (Investments) Limited dated October 1, 2013 (incorporated
by reference to Exhibit 10.12 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2014 filed with
the Commission on January 30, 2014).
10.11 † 22nd
Century Group, Inc. 2014 Omnibus Incentive Plan (incorporated by reference to Appendix B to the Company’s Definitive Proxy
Statement filed with the Commission on March 4, 2014).
10.12 † Form
of Restricted Stock Award Agreement under 22nd Century Group, Inc. 2014 Omnibus Incentive Plan (incorporated by reference to Exhibit
10.2 to the Company’s Form 8-K filed with the Commission on April 14, 2014).
10.13 † Form
of Stock Option Award Agreement under 22nd Century Group, Inc. 2014 Omnibus Incentive Plan (incorporated by reference to Exhibit
10.3 to the Company’s Form 8-K filed with the Commission on April 14, 2014).
10.14 † Employment
Agreement dated May 12, 2014 by and between the Company and Thomas James (incorporated by reference to Exhibit 10.1 to the Company’s
Form 8-K filed with the Commission on May 14, 2014).
10.15† Employment Agreement,
dated October 7, 2015, between Dr. Rushton and the Company (incorporated by reference to Exhibit 10.1 to the Company’s Form
8-K filed with the Commission on October 9, 2015).
10.16
*
††† Research Funding Agreement dated December 14, 2016 with The Rector and
Visitors of the University of Virginia, a not-for-profit Virginia educational institutional of the Commonwealth of Virginia.
10.17
*
††† Exclusive License Agreement dated December 14, 2016 with the University
of Virginia Patent Foundation d/b/a University of Virginia Licensing & Ventures Group, a Virginia non-profit corporation.
21.1* Subsidiaries.
23.1* Consent of Freed Maxick CPAs, P.C.
31.1*
Section 302 Certification.
31.2* Section 302 Certification.
32.1* Written Statement of Principal Executive
Officer and Chief Financial Officer pursuant to 18.U.S.C §1350.
101* Interactive data files formatted in XBRL
(eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations,
(iii) the Consolidated Statements of Cash Flows, and (iv) the Notes to the Consolidated Financial Statements.
101.INS XBRL Instance Document*
101.SCH XBRL Taxonomy Extension Schema ocument*
101.CAL XBRL Taxonomy Extension Calculation
Linkbase Document*
101.DEF XBRL Taxonomy Extension Definition Linkbase Document*
101.LAB XBRL Taxonomy Extension Label Linkbase
Document*
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document*
* Filed herewith.
† Management contract or compensatory
plan, contract or arrangement.
†† Certain
portions of the exhibit have been omitted pursuant to a confidential treatment order. An unredacted copy of the exhibit has been
filed separately with the United States Securities and Exchange Commission pursuant to the request for confidential treatment.
†††
Certain portions of the exhibit have been omitted pursuant to a request for confidential treatment. An unredacted copy of the
exhibit has been filed separately with the United States Securities and Exchange Commission pursuant to the request for confidential
treatment.