NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
June 30, 2017
(unaudited)
NOTE 1. - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
Basis of Presentation
-
The
accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally
accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q. Accordingly,
they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion
of management, all adjustments consisting of normal recurring accruals considered necessary for a fair and non-misleading
presentation of the financial statements have been included.
Operating results for the six
months ended June 30, 2017 are not necessarily indicative of the results that may be expected for the year ending December
31, 2017. The balance sheet as of December 31, 2016 has been derived from the audited consolidated financial statements at
that date, but does not include all the information and footnotes required by GAAP for complete financial statements.
These interim consolidated financial statements
should be read in conjunction with the December 31, 2016 audited consolidated financial statements and the notes thereto.
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”) (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 (i) for the level of nicotine and other nicotinic
alkaloids in tobacco plants to be decreased or increased through genetic engineering
and plant breeding and (ii) the levels of cannabinoids in cannabis/hemp plants to be decreased or increased through genetic engineering
and plant breeding. 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.
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.
Accounts receivable
- The
Company periodically reviews aged account balances for collectability. At June 30, 2017 and December 31, 2016, the Company
established an allowance for doubtful accounts in the amount of $0 and $10,000, respectively.
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 June 30, 2017 and December 31, 2016 consisted of the following:
|
|
June 30,
|
|
December 31,
|
|
|
2017
|
|
2016
|
|
|
|
|
|
Inventory - tobacco leaf
|
|
$
|
1,881,233
|
|
|
$
|
1,936,039
|
|
Inventory - finished goods
|
|
|
|
|
|
|
|
|
Cigarettes and filtered cigars
|
|
|
756,186
|
|
|
|
340,523
|
|
Inventory - raw materials
|
|
|
|
|
|
|
|
|
Cigarette and filtered cigar components
|
|
|
2,001,221
|
|
|
|
1,071,747
|
|
|
|
|
4,638,640
|
|
|
|
3,348,309
|
|
Less: inventory reserve
|
|
|
350,623
|
|
|
|
255,623
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
4,288,017
|
|
|
$
|
3,092,686
|
|
Machinery and equipment
-
Machinery and equipment 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 groupings of patent families, which expire in 2018 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 a predicate cigarette brand have an indefinite life and as such, no amortization is taken. Total
intangible assets at June 30, 2017 and December 31, 2016 consisted of the following:
|
|
June 30,
|
|
December 31,
|
|
|
2017
|
|
2016
|
Intangible assets, net
|
|
|
|
|
|
|
|
|
Patent and trademark costs
|
|
$
|
6,026,169
|
|
|
$
|
5,688,440
|
|
Less: accumulated amortization
|
|
|
2,256,813
|
|
|
|
2,021,926
|
|
Patent and trademark costs, net
|
|
|
3,769,356
|
|
|
|
3,666,514
|
|
|
|
|
|
|
|
|
|
|
License fees, net (see Note 13)
|
|
|
1,450,000
|
|
|
|
1,450,000
|
|
Less: accumulated amortization
|
|
|
277,580
|
|
|
|
228,568
|
|
License fees, net
|
|
|
1,172,420
|
|
|
|
1,221,432
|
|
|
|
|
|
|
|
|
|
|
MSA signatory costs
|
|
|
2,202,000
|
|
|
|
2,202,000
|
|
|
|
|
|
|
|
|
|
|
License fee for predicate cigarette brand
|
|
|
300,000
|
|
|
|
300,000
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
7,443,777
|
|
|
$
|
7,389,946
|
|
Amortization expense relating to the
above intangible assets for the three and six months ended June 30, 2017 amounted to $143,010 and $283,898, respectively
($126,041 and $250,882 for the three and six months ended June 30, 2016, respectively).
The estimated annual average amortization
expense for the next five years is approximately $387,000 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
six months ended June 30, 2017 or 2016.
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 June 30, 2017 and December 31, 2016.
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 were no pending audits as of June 30, 2017.
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 $1,985,000 and $3,544,000 are included
in net sales for the three and six months ended June 30, 2017, respectively (approximately $1,842,000 and $3,577,000 for the three
and six months ended June 30, 2016, respectively), except on sales of
SPECTRUM
research cigarettes, exported cigarettes
and exported filtered cigars and in-bond sales of filtered cigars to other federally licensed tobacco products manufacturers,
to which such taxes do not apply.
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.
There were no
SPECTRUM
research cigarettes delivered
during the six months ended June 30, 2017. Revenue generated from the sale of
SPECTRUM
research cigarettes amounted to
$0 and $329,321 for the six months ended June 30, 2017 and 2016, respectively. In May 2017, the Company received a purchase order
from RTI for approximately 2.4 million
SPECTRUM
research cigarettes.
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,
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 $12,000 and $43,000 for the three and
six months ended June 30, 2017, respectively ($27,000 and $235,000 for the three and six months ended June 30, 2016,
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 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. When the Company’s investment in equity securities falls
below 20% and the Company does not have the ability to have significant influence over the operating and financial policies of
the investee, the Company carries the equity investment at its cost basis.
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 revenue 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 is evaluating the implementation of
the applicable revenue recognition ASU’s for annual reporting periods beginning after December 15, 2017. As a result of
this potential implementation, the Company may exclude certain federal excise taxes 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. – JUNE 2017 WARRANT EXERCISE AGREEMENTS
On June
19, 2017, the Company entered into Warrant Exercise Agreements (the “Agreements”) with all of the holders (the “Holders”)
of outstanding warrants to purchase up to 7,043,211 shares of common stock of the Company at $1.00 per share and warrants to purchase
up to 4,250,000 shares of common stock of the Company at $1.45 per share (collectively, the “Warrants”). These Warrants
to purchase shares of the Company’s common stock were acquired by the Holders in registered direct offerings in October
of 2016 and in July of 2016, respectively, as more fully described in Notes 3 and 4 below. The Company and the Holders agreed
that the Holders would, subject to beneficial ownership limitations on exercise contained in the Warrants, exercise all the Warrants
for cash. In June 2017, the Holders exercised 3,229,711 Warrants at $1.00 per share and 2,354,948 Warrants at $1.45 per share,
resulting in net proceeds to the Company in the amount of $6,169,212, after deducting expenses associated with the transaction.
In
consideration for the Holders exercising their Warrants for cash, the Company issued to each Holder a new warrant (the
“New Warrants”) to purchase shares of common stock of the Company equal to the number of shares of common stock
received by each Holder upon the cash exercise of the Holder’s Warrants. The terms of the New Warrants are
substantially similar to the terms of the Warrants exercised, except the New Warrants (i) have an exercise price equal to
$2.15 per share and (ii) are exercisable six months from the date of issuance of the New Warrants for a period of five (5)
years. Accordingly, the Company issued 5,584,659 New Warrants to the Holders on June 20, 2017, upon exercise of the
Holder’s Warrants as described above. The New Warrants had a fair value of $6,913,808 at issuance and have been
recorded as an adjustment to capital in excess of par.
As described in Note 16, additional Warrants were exercised in
July and August of 2017 for cash, for a total of 5,708,552 Warrants exercised, generating net proceeds of $6,167,646, and the
Company issued 5,708,552 New Warrants.
NOTE 3. – 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 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 $3,380,000 at issuance. The holders of the warrants did
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 could 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 could
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. As of August 7,
2017, no such warrants remained outstanding.
NOTE 4. – JULY 2016 REGISTERED DIRECT OFFERING
On July 27, 2016, the Company closed
a registered direct offering of common stock and warrants 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 had 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. As of August 7, 2017, no such warrants remained outstanding. 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 previously
issued in conjunction with registered direct offerings in February of 2016 and June of 2015.
NOTE 5. - FEBRUARY 2016 REGISTERED DIRECT OFFERING
On February 5, 2016, the Company closed
a registered direct offering of common stock and warrants 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.
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 final amortization of the prepaid consulting fees amounted to $1,978,785 for the
three months ended March 31, 2015, and were included in General and administrative expenses in the Company’s Consolidated
Statements of Operations.
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.
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 six months ended June
30, 2017. However, in mid-May of 2017, the Company began manufacturing an existing brand of filtered cigars under a new
contract manufacturing agreement (the “New Agreement”) with a third-party, continued manufacturing a third-party
MSA cigarette brand, other filtered cigars on a contract basis and the Company’s own proprietary cigarette brand,
RED
SUN
. The New Agreement is expected to increase revenue, utilize a significant amount of excess production capacity,
require additional personnel and require an increase in working capital resources. 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 $215,941 and $334,691 for the three and six months ended June 30,
2017, respectively ($146,669 and $281,936 for the three and six months ended June 30, 2016, respectively).
NOTE 8. - MACHINERY AND EQUIPMENT
Machinery and equipment at June 30, 2017
and December 31, 2016 consisted of the following:
|
|
Useful Life
|
|
June
30,
2017
|
|
December
31,
2016
|
Cigarette manufacturing equipment
|
|
3 - 10 years
|
|
$
|
3,193,580
|
|
|
$
|
3,193,580
|
|
Office furniture, fixtures and equipment
|
|
5 years
|
|
|
104,538
|
|
|
|
103,945
|
|
Laboratory equipment
|
|
5 years
|
|
|
32,194
|
|
|
|
19,076
|
|
|
|
|
|
|
3,330,312
|
|
|
|
3,316,601
|
|
Less: accumulated depreciation
|
|
|
|
|
1,058,523
|
|
|
|
881,938
|
|
|
|
|
|
|
|
|
|
|
|
|
Machinery and equipment, net
|
|
|
|
$
|
2,271,789
|
|
|
$
|
2,434,663
|
|
Depreciation expense was $88,464 and
$176,585 for the three and six months ended June 30, 2017, respectively ($81,067 and $161,664 for the three and six months
ended June 30, 2016, respectively).
NOTE 9. - INVESTMENT IN ANANDIA
The Company (through its wholly-owned
subsidiary, Botanical Genetics) used the equity method of accounting to record its 24.4% ownership interest in Anandia
Laboratories, Inc., a Canadian plant biotechnology company (“Anandia”). The Company’s ownership was 25%
prior to a dilutive event on September 8, 2016, that reduced the Company’s ownership in Anandia to 24.4%. On February
17, 2017, an additional dilutive event (the “Dilutive Event”) reduced the Company’s ownership in Anandia
to 19.4%, an ownership percentage below the 20% threshold for the use of the equity method of accounting. Accordingly,
the Company discontinued applying the equity method of accounting for the investment in Anandia, effective on the date of
the Dilutive Event. At June 30, 2017 and December 31, 2016, the Company’s investment balance in Anandia was
$1,366,493 and $1,020,313, respectively, and is classified within Other assets on the accompanying Consolidated Balance
Sheets. After the Dilutive Event, the Company accounts for its investment in Anandia under the cost method.
The Company has recorded a gain on investment
of $0 and $16,872 for the three and six months ended June 30, 2017, respectively, and a loss of $40,427 and $113,247 for the three
and six months ended June 30, 2016, respectively (the gain for the six months ended June 30, 2017, reflects the Company’s
proportionate gain through the Dilutive Event). As of September 15, 2014, the carrying value of the Company’s investment
in Anandia was approximately $1,199,000 in excess of the Company’s share of the book value of the net assets of Anandia,
with such difference being attributable to intangible assets. This intangible asset was being amortized over the expected benefit
period and this amortization expense amounted to $0 and7,526 for the three and six months ended June 30, 2017, respectively ($14,412
and $28,824 for the three and six months ended June 30, 2016, respectively). After the Dilutive Event, the Company discontinued
amortizing this intangible asset. In addition, and as a result of the Dilutive Event, the Company recorded a gain in accordance
with the derecognition provisions of Accounting Standards Codification 323 (“ASC 323”). ASC 323 states that an investor
(the Company) shall account for an issuance by an investee (Anandia) as if the investor had sold a proportionate share if its
investment in the investee and the investor will record a gain or loss resulting from the investee share issuance. As such, the
Company recorded a gain of $336,834 during the three months ended March 31, 2017, as a result of the Dilutive Event. The Company’s
gain (loss) on the investment when aggregating the Company’s share of Anandia’s gain (loss), the intangible asset
amortization and the gain recorded under ASC 323 amounted to $0 and $346,180 for the three and six months ended June 30, 2017,
respectively, and amounted to ($54,839) and ($142,071) for the three and six months ended June 30, 2016, 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 payment 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 $320,554 and $307,938 at June 30, 2017 and December
31, 2016, respectively, and the amounts are reported as Current portion of note payable on the Company’s Consolidated Balance
Sheets. 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.
As a result of the severance benefit payments made through the second quarter of 2017, the discounted current balance of the severance
liability amounted to $90,101 and $199,657, at June 30, 2017 and December 31, 2016, respectively.
NOTE 12. - WARRANTS FOR COMMON STOCK
At June 30, 2017, the Company had outstanding
warrants to purchase 12,445,247 shares of common stock of the Company, of which warrants to purchase 94,721 shares contain an anti-dilution
feature and excluding 2,000,000 Tranche 2 and 3 warrants that will never become exercisable, as discussed in Note 6.
During the second quarter of 2017, warrants
to purchase 843,110 shares of common stock were exercised on a cashless basis resulting in the issuance of 525,118 shares of the
Company’s common stock and 5,657,159 warrants to purchase shares of common stock were exercised on a cash basis (including
5,584,659 warrants to purchase shares of common stock under the Warrant Exercise Agreements discussed in Note 2). On May 15, 2017,
warrants to purchase 45,834 shares of common stock expired without being exercised. As discussed in Note 16, subsequent to June
30, 2017, an additional 5,708,552 warrants were exercised.
During June of 2017, the Company issued
warrants to purchase 5,584,659 shares of common stock with an exercise price of $2.15 per share. These warrants have a term of
sixty-six (66) months, were not exercisable for six months immediately following the date of issuance, do not contain an anti-dilution
feature and had a fair value of $6,913,808 at issuance. As discussed in Note 16, subsequent to June 30, 2017, the Company issued
an additional 5,708,552 warrants as a result of a cash exercise of existing warrants. See Note 2 for additional details.
During March of 2017, warrants to purchase
202,500 shares of common stock were exercised on a cashless basis resulting in the issuance of 100,928 shares of the Company’s
common stock. On February 8, 2017, warrants to purchase 172,730 shares of common stock expired without being exercised.
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 3, 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 Warrant Exercise Agreements, as discussed in Note 2, warrants to purchase 2,354,948 shares of common
stock were exercised on a cash basis at an exercise price of $1.45 per share and, as discussed in Note 16, an aggregate
of 1,895,052 warrants were exercised in July and August of 2017.
Pursuant to the registered
direct offering that closed on July 27, 2016, and discussed in Note 4, 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 had 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 previously issued in
conjunction with registered direct offerings in February of 2016 and June of 2015. Pursuant to the June 2017 Warrant Exercise
Agreements, as discussed in Note 2, warrants to purchase 3,229,711 shares of common stock were exercised on a cash basis at
an exercise price of $1.00 per share and, as discussed in Note 16, an aggregate of 3,813,500 warrants were exercised in July
and August of 2017.
Pursuant to the registered direct offering
that closed on February 5, 2016, and discussed in Note 5, 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 4 – July 2016 Registered
Direct Offering for additional information).
Pursuant to the registered direct offering
that closed on June 2, 2015, 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 4 – July 2016 Registered Direct Offering for additional information).
Outstanding warrants at June 30, 2017 consisted
of the following:
Warrant Description
|
|
Number of
Warrants
|
|
Exercise
Price
|
|
Expiration
|
December 2011 convertible NP warrants
|
|
|
802,215
|
|
|
$
|
1.3816
|
|
|
February 6, 2018
|
November 2012 PPO warrants
|
|
|
255,100
|
|
|
$
|
0.6000
|
|
|
November 9, 2017
|
August 2012 convertible NP warrants
(1)
|
|
|
94,721
|
|
|
$
|
0.9310
|
|
|
August 8, 2018
|
July 2016 registered direct offering warrants
(2)
|
|
|
3,813,500
|
|
|
$
|
1.0000
|
|
|
January 27,2021
|
October 2016 registered direct offering warrants
(2)
|
|
|
1,895,052
|
|
|
$
|
1.4500
|
|
|
April 19, 2022
|
June 2017 warrants pursuant to warrant exercise agreements
(3)
|
|
|
5,584,659
|
|
|
$
|
2.1500
|
|
|
December 20, 2022
|
|
|
|
|
|
|
|
|
|
|
|
Total warrants outstanding
(4)
|
|
|
12,445,247
|
|
|
|
|
|
|
|
(1)
|
Includes anti-dilution features.
|
(2)
|
As of August 7, 2017, no such warrants were outstanding. See Note 16.
|
(3)
|
As of August 7, 2017, after an aggregate of 5,708,552 additional warrants were issued in
July and August of 2017, 11,293,211 of such warrants were outstanding. See
Note 16.
|
(4)
|
Excludes 2,000,000 Tranche 2 and 3 warrants that will
never become exercisable, as discussed in Note 6.
|
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 following table is a roll-forward summary
of the warrant liability:
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
|
|
Loss as a result of change in fair value
|
|
|
82,927
|
|
Fair value at June 30, 2017
|
|
$
|
141,608
|
|
The aggregate loss as a result of the Company’s
warrant liability for the three and six months ended June 30, 2017 amounted to ($77,583) and ($82,927), respectively (the aggregate
net (loss) gain for the three and six months ended June 30, 2016 amounted to ($9,468) and $61,597, respectively), which are included
in Other income (expense) under Warrant liability (loss) gain - 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, 2015:
|
|
Number of
Warrants
|
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
|
|
Warrants expired during February 2017
|
|
|
(172,730
|
)
|
Warrants exercised during March 2017
|
|
|
(202,500
|
)
|
Warrants exercised during April 2017
|
|
|
(162,000
|
)
|
Warrants exercised during May 2017
|
|
|
(221,366
|
)
|
Warrants expired during May 2017
|
|
|
(45,834
|
)
|
Warrants exercised during June 2017
|
|
|
(6,116,903
|
)
|
Warrants issued pursuant to June 2017 warrant exercise agreements
|
|
|
5,584,659
|
|
Warrants outstanding at June 30, 2017
|
|
|
12,445,247
|
|
|
|
|
|
|
Composition of outstanding warrants:
|
|
|
|
|
Warrants containing anti-dilution feature
|
|
|
94,721
|
|
Warrants without anti-dilution feature
|
|
|
12,350,526
|
|
|
|
|
12,445,247
|
|
NOTE 13. - 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 beginning in 2016 and for subsequent years is $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 three and six months ended June
30, 2017, the aggregate costs incurred related to capitalized patent costs and patent maintenance expense amounted to $4,866
and $31,709, respectively ($10,016 and $13,996 during the three and six months ended June 30, 2016, 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 three and six months ended June 30, 2017, the aggregate costs incurred related to
capitalized patent costs and patent maintenance expense amounted to $199 and $29,866, respectively, ($0 and $6,075 for the
three and six months ended June 30, 2016, respectively). This License continues through the life of the last-to-expire
patent, expected to be in 2035.
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 had extended the Agreement through January 31, 2017 at an additional cost of $85,681. The Company is currently negotiating
an additional extension to this Agreement.
All payments made under the above referenced
license agreements 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 three and
six months ended June 30, 2017 were $56,250 and $119,640, respectively ($115,170 and $229,967 for the three and six months ended
June 30, 2016, 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 for a license fee of $1,250,000. 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, and the Company must pay to NCSU an additional
non-refundable, non-creditable lump sum fee of $75,000 upon issuance of a U.S. utility patent included in the patent rights. A
patent was issued during the first quarter of 2017 under this clause, and accordingly, the $75,000 was due and payable to NCSU.
The $75,000 cost was included in Research and development costs on the Company’s Consolidated Statements of Operations for
the three months ended March 31, 2017. 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 three and six months ended June 30, 2017, the aggregated costs incurred
related to capitalized patent costs and patent maintenance expense amounted to $5,173 and $24,242, respectively, ($5,983 and $33,939
for the three and six months June 30,2016, 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. The Anandia Sublicense required 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
amounted to $24,505 and $49,011 for the three months and six months ended June 30, 2017, respectively ($24,505 and $49,011 for
the three and six months ended June 30, 2016, respectively) and was included in Amortization expense 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
is conducting research on behalf of the Company relating to the cannabis/hemp plant. The Agreement had 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 (of which the option on one twelve (12) month period has been extended). The
Company paid Anandia $379,800 over the initial term of the Agreement. On March 13, 2017, the Company entered into Amendment
No. 1 to the Agreement (the “Amendment”). The Amendment has a term of twelve (12) months and calls for the
Company to pay Anandia a total of $785,100 in equal monthly installments of $65,425. During the three and six months ended
June 30, 2017, expenses related to the Agreement amounted to $196,275 and $261,700, respectively ($84,200 and $179,200, for
the three and six months ended June 30, 2016, 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. 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 the Company 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 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. During the three and six months ended June 30, 2017, expenses related to the agreements amounted to $70,729 and $111,574,
respectively, ($48,344 and $112,973 for the three and six months ended June 30, 2016, respectively) and are included in Research
and development costs on the Company’s Consolidated Statements of Operations.
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
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 three and six months ended June 30, 2017 amounted to $38,438 and $76,876, respectively,
($36,131 and $72,262, for the three and six months ended June 30, 2016, respectively). The future minimum lease payments if the
Company exercises each of the additional extensions are approximately as follows:
Year ended December 31, 2017 -
|
|
$
|
79,000
|
|
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 $8,000.
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. Future minimum lease payments for the years ended December 31, 2017, 2018 and 2019 will be
$22,500, $45,000 and $37,500, respectively. In October of 2016, the Company exercised the three-year renewal option after the
one-year initial term.
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 through April
30, 2018. Additionally, on February 1, 2017, the Company entered into an amendment to the initial sublease calling for the
sublease of additional lab space at a cost of $1,219 per month, bringing the total monthly lease obligation to $2,690. On
April 26, 2017, the Company entered into an amendment to the sublease to extend the term of the sublease for an additional
twelve (12) months, commencing on May 1, 2017 at a total cost of $2,770 per month for the total lease obligation. Future
minimum lease payments for the years ended December 31, 2017 and 2018 will be approximately $16,000 and $11,000,
respectively.
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 $7,200 and $14,400
per year for each subsequent year the warehouse space is sublet by the Company.
On April 20, 2017, the Company entered into
a lease for warehouse space in North Carolina to store cigarette and filtered cigar raw materials. The lease calls for a monthly
payment of $3,500 on a month-to-month basis. Future minimum lease payments for the year ended December 31, 2017 are $21,000 and
$42,000 in subsequent years as long as the Company continues to lease the warehouse space.
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 included 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 issues its decision on the summary judgment motion of the Company.
On March 20, 2017, the Company filed its
motion for summary judgment for the claims remaining in the SDNY Court. The response by Crede to the Company’s summary judgment
motion was filed by Crede on May 1, 2017. On May 15, 2017, the Company filed its response to Crede’s filing. The parties
are now awaiting the SDNY Court to issue its decision on such summary judgment motion.
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 14. - EARNINGS PER COMMON SHARE
The following table sets forth the computation
of basic and diluted earnings per common share for the three-month periods ended June 30, 2017 and 2016:
|
|
June 30,
2017
|
|
June 30,
2016
|
Net loss attributed to common shareholders
|
|
$
|
(3,355,624
|
)
|
|
$
|
(2,902,354
|
)
|
|
|
|
|
|
|
|
|
|
Denominator for basic earnings per share-weighted average shares outstanding
|
|
|
91,577,688
|
|
|
|
76,024,064
|
|
|
|
|
|
|
|
|
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
Warrants, restricted stock and options outstanding
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Denominator for diluted earnings per common share-weighted average shares adjusted for dilutive securities
|
|
|
91,577,688
|
|
|
|
76,024,064
|
|
|
|
|
|
|
|
|
|
|
Loss per common share - basic and diluted
|
|
$
|
(0.04
|
)
|
|
$
|
(0.04
|
)
|
The following table sets forth the computation
of basic and diluted earnings per common share for the six-month periods ended June 30, 2017 and 2016:
|
|
June 30,
2017
|
|
June 30,
2016
|
Net loss attributed to common shareholders
|
|
$
|
(5,976,901
|
)
|
|
$
|
(6,154,806
|
)
|
|
|
|
|
|
|
|
|
|
Denominator for basic earnings per share-weighted average shares outstanding
|
|
|
91,165,770
|
|
|
|
75,027,606
|
|
|
|
|
|
|
|
|
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
Warrants, restricted stock and options outstanding
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Denominator for diluted earnings per common share-weighted average shares adjusted for dilutive securities
|
|
|
91,165,770
|
|
|
|
75,027,606
|
|
|
|
|
|
|
|
|
|
|
Loss per common share - basic and diluted
|
|
$
|
(0.07
|
)
|
|
$
|
(0.08
|
)
|
Securities outstanding that were excluded
from the computation because they would have been anti-dilutive are as follows:
|
|
June 30,
2017
|
|
June 30,
2016
|
Warrants
|
|
|
12,445,247
|
|
|
|
10,236,621
|
|
Options
|
|
|
6,965,688
|
|
|
|
4,985,679
|
|
|
|
|
19,410,935
|
|
|
|
15,222,300
|
|
NOTE 15. – EQUITY BASED COMPENSATION
On April 12, 2014, the stockholders of
the Company approved the 22nd Century Group, Inc. 2014 Omnibus Incentive Plan (the “OIP”) and on April 29, 2017,
the shareholders approved an amendment to the OIP to increase the number of shares available for issuance by 5,000,000
shares. 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 an aggregate of 10,000,000 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. As of June 30, 2017, we had available 3,949,765
shares remaining for future awards under the OIP.
During the three months ended June
30, 2017, the Company issued stock option awards from the OIP for 1,372,000, to eligible individuals having vesting
periods ranging from one to three years from the date of the award. There were no equity awards from the OIP during the three
months ended March 31, 2017. During the three and six months ended June 30, 2016, the Company issued stock option awards from
the OIP for 90,000 shares and 1,724,037 shares, respectively. All stock option awards were valued using the Black-Scholes
option-pricing model on the date of the award.
For the three and six months
ended June 30, 2017, the Company recorded compensation expense related to restricted stock and stock option awards granted
under the OIP of $154,004 and $322,983, respectively, ($212,222 and $472,216 for the three and six months ended June 30,
2016, respectively). During the three and six months ended June 30, 2017, there were no issuances of stock to third-party
service providers. During the three and six months ended June 30, 2016, the Company issued stock to third-party service
providers in the amount of 10,000 shares and 15,811 shares, respectively, and during the three months ended June 30, 2016,
the Company issued stock options in the amount of 100,000 shares to a third-party service provider. The Company had no equity
based compensation expense related to third-party providers for the three and six months ended June 30, 2017. During the
three and six months ended June 30, 2016, the Company recorded equity based compensation expense related to third-party
providers in the amount of $8,000 and $30,873, respectively.
As of June 30, 2017, unrecognized compensation
expense related to non-vested restricted shares and stock options amounted to approximately $2,390,000, which is expected to be
recognized approximately as follows: $507,000, $828,000, $448,000 and $140,000 during 2017, 2018, 2019 and 2020, 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 six months ended
June 30, 2017 and 2016:
|
|
2017
|
|
2016
|
Risk-free interest rate (weighted average)
|
|
|
2.12
|
%
|
|
|
1.38
|
%
|
Expected dividend yield
|
|
|
0
|
%
|
|
|
0
|
%
|
Expected stock price volatility
|
|
|
90
|
%
|
|
|
90
|
%
|
Expected life of options (weighted average)
|
|
|
5.13 years
|
|
|
|
5.03 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, 2015 is as follows:
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
Weighted
|
|
Remaining
|
|
Aggregate
|
|
|
Number of
|
|
Average
|
|
Contractual
|
|
Intrinsic
|
|
|
Options
|
|
Exercise Price
|
|
Term
|
|
Value
|
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
|
|
|
|
|
|
|
|
Granted in 2017
|
|
|
1,372,000
|
|
|
$
|
1.39
|
|
|
|
|
|
|
|
Exercised in 2017
|
|
|
(56,991
|
)
|
|
$
|
0.72
|
|
|
|
|
|
|
|
Outstanding at June 30, 2017
|
|
|
6,965,688
|
|
|
$
|
1.12
|
|
|
7.3 years
|
|
$
|
4,681,882
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at June 30, 2017
|
|
|
3,663,334
|
|
|
$
|
1.11
|
|
|
6.2 years
|
|
$
|
2,611,378
|
|
There were stock options granted during
the six months ended June 30, 2017 and 2016, to purchase a total of 1,372,000 shares and 1,824,037 shares, respectively. The weighted
average grant date fair value of options issued during the six months ended June 30, 2017 was $0.97 ($0.64 for the six months ended
June 30, 2016). The total fair value of options that vested during the six months ended June 30, 2017 amounted to $684,265 ($1,138,910
for the six months ended June 30, 2016). There were 56,991 options exercised during the six months ended June 30, 2017 and during
the six months ended June 30, 2016 no options were exercised.
NOTE 16. - SUBSEQUENT EVENTS
In July and August
of 2017, certain of the Holders of the Warrants discussed in Note 2 exercised an aggregate of 3,813,500 Warrants with an
exercise price of $1.00 per share and an aggregate of 1,895,052 Warrants with an exercise price of $1.45 per share for cash,
resulting in net cash proceeds to the Company of $6,167,646, after deducting expenses associated with the exercise. In
consideration for Holders exercising their Warrants for cash, the Company issued to those Holders new warrants (the
“New Warrants”) to purchase shares of common stock of the Company equal to the number of shares of common stock
received by the Holders upon the cash exercise of each such Holder’s Warrants. The terms of the New Warrants are
substantially similar to the terms of the Warrants exercised, except the New Warrants (i) have an exercise price equal to
$2.15 per share and (ii) are exercisable beginning December 20, 2017 for a period of five (5) years. Accordingly, the Company
issued an aggregate of 5,708,552 New Warrants to the Holders in July and August of 2017, upon exercise of such
Holder’s Warrants as described above. The New Warrants had a fair value of approximately $9,100,000 at issuance.