NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
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 (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 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) potential modified risk tobacco products and (ii) smoking cessation product,
respectively. NASCO is a federally licensed tobacco products manufacturer, a subsequent participating member under the tobacco
Master Settlement Agreement (“MSA”) between the tobacco industry and the settling states under the MSA and operates
the Company’s tobacco products manufacturing business in North Carolina. Botanical Genetics is a wholly-owned subsidiary
of 22nd Century Group and was incorporated to facilitate the original investment in Anandia Laboratories, Inc., more fully described
in Note 9, and performs research and development related to the Company’s hemp business.
Reclassifications
-
Certain
items in the 2017 and 2016 financial statements have been reclassified to conform to the 2018 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
-
The
Company maintains its cash in bank deposits which, at times, may exceed federally insured limits. The Company has not experienced
any losses on such accounts. The Company believes it is not exposed to any significant risk with respect to its cash accounts.
Cash
and cash equivalents
– The Company considers all highly liquid investments with maturities of three months or less
at the date of acquisition to be cash equivalents. Cash equivalents included in this category consist of a bank certificate of
deposit in the amount of $0 and $3,000,000 at December 31, 2018 and 2017, respectively. Cash and cash equivalents are stated at
cost, which approximates fair value.
Short-term investment securities
– The Company’s short-term investment securities are classified as available-for-sale securities and consist
of money market funds, corporate bonds, U.S. government agency bonds, U.S. treasury securities, and commercial paper with maturities
greater than three months at the time of acquisition. The Company’s short-term investment securities are carried at fair
value within current assets on the Company’s Consolidated Balance Sheets. The Company views its available-for-sale securities
as available for use in current operations regardless of the stated maturity date of the security. The Company’s investment
policy states that all investment securities must have a maximum maturity of twenty-four (24) months or less and the maximum weighted
maturity of the investment securities must not exceed twelve (12) months. Unrealized gains and losses on short-term investment
securities (the adjustment to fair value) are recorded as other comprehensive income or loss on the Company’s Consolidated
Statements of Operations and Comprehensive Loss. Realized gains and losses on short-term investment securities are recorded in
the other income (expense) portion of the Company’s Consolidated Statements of Operations and Comprehensive Loss. Interest
earned, net of investment fees, on the short-term investment securities are included in interest income.
Accounts receivable
-
The Company periodically reviews aged account balances for collectability. The Company established an allowance for doubtful accounts
of $0 at both December 31, 2018 and December 31, 2017.
Inventory
-
Inventories
are valued at the lower of cost or net realizable value. 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, 2018 and December 31, 2017 consisted of the following:
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2018
|
|
|
2017
|
|
Inventory - tobacco leaf
|
|
$
|
1,556,581
|
|
|
$
|
1,552,474
|
|
Inventory - finished goods
|
|
|
|
|
|
|
|
|
Cigarettes and filtered cigars
|
|
|
156,702
|
|
|
|
289,004
|
|
Inventory - raw materials
|
|
|
|
|
|
|
|
|
Cigarette and filtered cigar components
|
|
|
1,430,666
|
|
|
|
1,636,059
|
|
|
|
|
3,143,949
|
|
|
|
3,477,537
|
|
Less: inventory reserve
|
|
|
100,000
|
|
|
|
195,000
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
3,043,949
|
|
|
$
|
3,282,537
|
|
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 granted patent assets in each of the Company’s patent families, which have estimated
expiration dates ranging from 2019 to 2036. 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 are expected to range from 2019 through 2036. 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 December 31, 2018 and 2017 consisted of the following:
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2018
|
|
|
2017
|
|
Intangible assets, net
|
|
|
|
|
|
|
|
|
Patent and trademark costs
|
|
$
|
7,136,774
|
|
|
$
|
6,327,467
|
|
Less: accumulated amortization
|
|
|
3,194,565
|
|
|
|
2,517,465
|
|
Patent and trademark costs, net
|
|
|
3,942,209
|
|
|
|
3,810,002
|
|
|
|
|
|
|
|
|
|
|
License fees, net (see Note 14)
|
|
|
3,776,426
|
|
|
|
1,450,000
|
|
Less: accumulated amortization
|
|
|
469,131
|
|
|
|
326,591
|
|
License fees, net
|
|
|
3,307,295
|
|
|
|
1,123,409
|
|
|
|
|
|
|
|
|
|
|
MSA signatory costs
|
|
|
2,202,000
|
|
|
|
2,202,000
|
|
|
|
|
|
|
|
|
|
|
License fee for predicate cigarette brand
|
|
|
300,000
|
|
|
|
300,000
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
9,751,504
|
|
|
$
|
7,435,411
|
|
Amortization expense relating to the above
intangible assets for the years ended December 31, 2018, 2017, and 2016 amounted to $819,640, $593,562 and $516,056, respectively.
The estimated annual average amortization
expense for the next five years is approximately $445,000 for patent costs and $238,000 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, 2018, 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 U.S. 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, 2018 and 2017.
The Company’s federal and state tax
returns for the years ended December 31, 2015 through December 31, 2017 are currently open to audit under the statutes of limitations.
There are no pending audits as of December 31, 2018.
The Tax Cuts and Jobs Act of 2017 (the “TCJA”)
was signed into law on December 22, 2017. The TCJA includes significant changes to the U.S. corporate income tax system, including
a Federal corporate rate reduction from 35% to 21%. In accordance with a question and answer document issued by the Financial Accounting
Standards Board (“FASB”) staff on January 18, 2018, the Company is applying the guidance in Securities and Exchange
Commission Staff Accounting Bulletin (“SAB”) 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act,
which provides guidance on applying FASB Accounting Standards Codification (“ASC”) 740, Income Taxes, if the accounting
for certain income tax effects of the TCJA are incomplete by the time the financial statements are issued for a reporting period.
Specifically, SAB 118 permits companies to use reasonable estimates and provisional amounts for some line items for taxes when
preparing year-end 2018 and 2017 financial statements. The Company has completed the accounting under the TCJA, and accordingly,
has reported the effects in the Company’s consolidated financial statements for the years ended December 31, 2018 and 2017.
Additional disclosures required by SAB 118 are included in Note 17.
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 -
On January
1, 2018, the Company adopted ASC 606, Revenue from Contracts with Customers and all related amendments (the “new revenue
standard”) for all contracts using the modified retrospective method. Under the modified retrospective method, the Company
was required to record a cumulative-effect adjustment to the opening balance of retained earnings on January 1, 2018. The Company
has determined that the adoption of the new revenue standard did not require a cumulative-effect adjustment. The comparative information
has not been restated and continues to be reported under the accounting standards in effect for those periods.
The Company recognizes revenue
when it satisfies a performance obligation by transferring control of the product to a customer. The Company’s customer contracts
consist of obligations to manufacture the customer’s branded filtered cigars and cigarettes. For certain contracts, the performance
obligation is satisfied over time as the Company determines, due to contract restrictions, it does not have an alternative use
of the product, and it has an enforceable right to payment as the product is manufactured. The Company recognizes revenue under
those contracts at the unit price stated in the contract based on the units manufactured. The manufacturing process is completed
on a daily basis and, therefore, there were no performance obligations partially satisfied at December 31, 2018. For contracts
where the performance obligation is satisfied at a point in time, the Company recognizes revenue when the product is transferred
to the customer. Revenue from the sale of the Company’s products is recognized net of cash discounts, sales returns and allowances.
There was no allowance for discounts or returns and allowances at December 31, 2018 and 2017.
The Company generally requires
a down payment from its customers prior to commencement of manufacturing the product. Amounts received in advance of satisfying
the performance obligations are recorded as deferred revenue. Customer payment terms vary depending on the terms of each customer
contract, but payment is generally due prior to product shipment or within extended credit terms up to twenty-one (21) days after
shipment.
The Company’s net sales
revenue is derived from customers located primarily in the United States of America and is disaggregated by the timing of revenue
recognition. For the year ended December 31, 2018, net sales revenue from products transferred over time amounted to approximately
$16,785,000 and net sales revenue from products transferred at a point in time amounted to approximately $9,641,000.
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. Derivative financial instruments are initially recorded at fair market value and then are revalued at
each reporting date, with changes in fair value reported in the Consolidated Statements of Operations and Comprehensive Loss.
The classification of derivative instruments are evaluated at the end of each reporting period. Derivative instruments 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 $36,000, $75,000 and $325,000 for the years ended
December 31, 2018, 2017, and 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.
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 -
The Company’s financial instruments include cash and cash equivalents, short-term investment
securities, accounts receivable, investments (stock warrants), accounts payable, accrued expenses, notes payable, and
warrant liability. Other than for cash equivalents, short-term investment securities, investments (stock warrants), and
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 cash equivalents, short-term
investment securities, investments (stock warrants), and warrant liability are discussed in Note 10.
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 of the other entity 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. If the Company’s equity investment
in other entities is less than 20%, and the Company has no significant influence over the operating or financial policies of the
entity, and such equity investment does not have a readily determinable market value, then the Company accounts for such equity
investments in accordance with FASB ASU 2016-01, which the Company adopted in the first quarter of 2018 with respect to the Company’s
investment in Anandia Laboratories, Inc. in Canada (see Note 9 for a further discussion). The Company used the cost method of accounting
with respect to its investment in Anandia Laboratories for prior periods.
The Company has an investment in stock warrants
that are considered equity securities under ASC 321 – Investments – Equity Securities and a derivative instrument under
ASC 815 – Derivatives and Hedging. The stock warrants are not designated as a hedging instrument, and in accordance with ASC
815, the Company’s investment in stock warrants are recorded at fair value with changes in fair value recorded in the Company’s
Consolidated Statements of Operations and Comprehensive Loss.
Accounting Pronouncements -
In
February 2016, the FASB issued ASU 2016-02, “Leases,” which supersedes existing lease guidance under U.S. 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 adopted ASU 2016-02 on January 1, 2019
and has completed an assessment of its current lease contracts. As a result, the Company has determined that its current leases,
primarily pertaining to real estate, are operating leases under the new guidance. Accordingly, effective January 1, 2019, the Company
will record a right-to-use asset and a corresponding lease liability in the approximate amount of $800,000.
NOTE 2. – OCTOBER 2017 REGISTERED DIRECT OFFERING
On October 10, 2017, the Company closed
a registered direct offering with institutional investors purchasing an aggregate of 20,570,000 shares of the Company’s common
stock at a price of $2.6250 per share generating net cash proceeds for the Company of $50,732,200, after deducting expenses associated
with the transaction.
NOTE 3. – JUNE 2017 WARRANT EXERCISE AGREEMENTS
On June 19, 2017, the Company entered into
Warrant Exercise Agreements (the “Agreements”) with all 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. 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. During the second and third quarters of 2017, the Holders
exercised 7,043,211 Warrants at $1.00 per share and 4,250,000 Warrants at $1.45 per share, resulting in net proceeds to the Company
in the amount of $12,336,858, 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 an aggregate of 11,293,211 New Warrants to
the Holders, upon exercise of the Holder’s Warrants as described above. The New Warrants had a fair value of $16,049,031
at issuance and have been recorded as an adjustment to capital in excess of par value.
NOTE 4. – 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
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. All the warrants issued in the offering were exercised as described in
Note 3 above.
NOTE 5. – 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 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.
All the warrants issued in the offering were exercised as described in Note 3 above.
NOTE 6. - 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 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 7. - MANUFACTURING FACILITY
The Company’s manufacturing operations at its North Carolina factory continued to utilize additional
production capacity due to increased production and sales of the contract manufacturing of filtered cigars and cigarettes during
the year ended December 31, 2018. This improvement resulted in gross profit on sales of products in the amount of $898,987 for
the year ended December 31, 2018, as compared to a gross loss on sales of products in the amount of $707,912 and $429,699 for the
years ended December 31, 2017, and 2016, respectively. 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 $1,308,613, $943,185 and $551,678 for the years ended December 31, 2018, 2017, and 2016, respectively.
NOTE 8. - MACHINERY AND EQUIPMENT
Machinery and equipment at December 31,
2018 and December 31, 2017 consisted of the following:
|
|
Useful Life
|
|
December 31,
2018
|
|
|
December 31,
2017
|
|
Cigarette manufacturing equipment
|
|
3 - 10 years
|
|
$
|
4,608,267
|
|
|
$
|
4,302,299
|
|
Office furniture, fixtures and equipment
|
|
5 years
|
|
|
135,909
|
|
|
|
110,499
|
|
Laboratory equipment
|
|
5 years
|
|
|
104,709
|
|
|
|
32,193
|
|
Leasehold improvements
|
|
6 years
|
|
|
169,362
|
|
|
|
106,429
|
|
|
|
|
|
|
5,018,247
|
|
|
|
4,551,420
|
|
Less: accumulated depreciation
|
|
|
|
|
1,757,499
|
|
|
|
1,235,373
|
|
Machinery and equipment, net
|
|
|
|
$
|
3,260,748
|
|
|
$
|
3,316,047
|
|
Depreciation expense was $522,695, $353,435
and $326,124 for the years ended December 31, 2018, 2017, and 2016, respectively.
NOTE 9. - INVESTMENT
The Company (through its wholly-owned subsidiary,
Botanical Genetics) held an equity investment in Anandia Laboratories, Inc., a Canadian plant biotechnology company (“Anandia”).
On August 8, 2018, all of Anandia’s outstanding common stock was acquired by Aurora Cannabis, Inc. (“Aurora”),
a Canadian company (TSX: ACB.TO), in exchange for (i) free trading shares of Aurora common stock, and (ii) warrants with a five-year
term to purchase one-half of a share of Aurora common stock for each whole share of Aurora common stock received as part of the
transaction (the “Anandia transaction”). As a result of the Anandia transaction, the Company received 1,947,943
shares of Aurora common stock and warrants to purchase 973,971 shares of Aurora common stock that had a fair value of $9,221,594
and $2,807,958, respectively. The Company recorded a realized gain on the transaction in the amount of $4,515,971 during the third
quarter of 2018. Additionally, the unrealized gain on the Company’s investment in Anandia in the amount of $6,147,088 under
ASU 2016-01 from the first quarter of 2018 became a realized gain at time of the Anandia transaction (see the paragraph below for
additional details). Subsequent to the transaction, the Company sold all of its Aurora common stock resulting in net sales proceeds
to the Company of $13,051,503 and realized a gain on the sale of $3,829,909 during the year ended December 31, 2018. The Anandia
transaction, the gain from ASU 2016-01, and the sale of the Aurora common shares resulted in an aggregate realized gain of $14,492,968
for the year ended December 31, 2018.
The warrants to purchase 973,971 shares
of Aurora common stock have a five-year contractual term, an exercise price of C$9.37 per share (Canadian Dollars; approximately
$6.87 per share U.S. Dollars at December 31, 2018), are currently exercisable, are considered an equity security, and are recorded
at fair value (Level 3 of the valuation hierarchy). The Company recorded the fair value of the Aurora common stock warrants of
$3,092,358 at December 31, 2018, using the Black-Scholes pricing model, and recorded an unrealized gain on the warrants in the
amount of $284,400 for the year ended December 31, 2018.
Effective January 1, 2018, the Company
adopted Financial Accounting Standards Board ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition
and Measurement of Financial Assets and Financial Liabilities. This guidance changes how entities account for equity investments
that do not result in consolidation and are not accounted for under the equity method of accounting. Under ASU 2016-01, the Company
is required to measure its investment in Anandia at fair value at the end of each reporting period and recognize changes in fair
value in net income. As allowed by ASU 2016-01, since the Company’s investment in Anandia did not have readily determinable
fair value, the Company elected to account for its investment at cost. The cost basis is required to be adjusted in the event
of impairment, if any, and for any observable price changes in orderly transactions for the identical or a similar investment
of the same issuer. Accordingly, and as a result of, an equity issuance in January of 2018 by Anandia that was considered an orderly
transaction, the Company recorded an unrealized gain on its investment in Anandia in the amount of $6,147,088 during the three
months ended March 31, 2018. There were no further changes in the fair value of the Company’s equity investment in Anandia
through the acquisition of Anandia by Aurora on August 8, 2018, and this unrealized gain became a realized gain as a result of
the Anandia transaction, as discussed above.
The Company’s investment in Anandia
was recorded using the equity method of accounting until the first quarter of 2017, when a dilutive event occurred bringing the
Company’s investment percentage in Anandia below 20%. Accordingly, the Company discontinued applying the equity method of
accounting for its investment in Anandia and began accounting for its investment in Anandia under the cost method of accounting.
The Company’s unrealized gain (loss) on the investment in Anandia was $346,180 and ($202,338) for the years ended December
31, 2017 and 2016, respectively. There was no unrealized gain (loss) for the year ended December 31, 2018. At December 31, 2017,
the Company’s investment balance in Anandia was $1,366,493, and was classified within Other assets on the accompanying Consolidated
Balance Sheets.
NOTE 10. – FAIR VALUE MEASUREMENTS AND SHORT-TERM
INVESTMENTS
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 following table presents information
about our assets and liabilities measured at fair value at December 31, 2018 and 2017, and indicates the fair value hierarchy of
the valuation techniques the Company utilized to determine such fair value:
|
|
Asset and Liabilities at Fair Value
|
|
|
|
As of December 31, 2018
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term investment securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money market funds
|
|
$
|
10,083,972
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
10,083,972
|
|
Corporate bonds
|
|
|
|
|
|
|
38,579,055
|
|
|
|
-
|
|
|
|
38,579,055
|
|
U.S. treasury securities
|
|
|
-
|
|
|
|
2,970,900
|
|
|
|
|
|
|
|
2,970,900
|
|
U.S. government agency bonds
|
|
|
-
|
|
|
|
4,115,012
|
|
|
|
-
|
|
|
|
4,115,012
|
|
Total short-term investment securities
|
|
$
|
10,083,972
|
|
|
$
|
45,664,967
|
|
|
$
|
-
|
|
|
$
|
55,748,939
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock warrants
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
3,092,358
|
|
|
$
|
3,092,358
|
|
|
|
Asset and Liabilities at Fair Value
|
|
|
|
As of December 31, 2017
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Certificate of deposit
|
|
$
|
-
|
|
|
$
|
3,000,000
|
|
|
$
|
-
|
|
|
$
|
3,000,000
|
|
Short-term investment securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Certificates of deposit
|
|
|
-
|
|
|
|
6,000,000
|
|
|
|
-
|
|
|
|
6,000,000
|
|
Money market funds
|
|
|
41,526,540
|
|
|
|
-
|
|
|
|
-
|
|
|
|
41,526,540
|
|
Corporate bonds
|
|
|
|
|
|
|
9,450,933
|
|
|
|
-
|
|
|
|
9,450,933
|
|
U.S. government agency bonds
|
|
|
-
|
|
|
|
1,998,040
|
|
|
|
-
|
|
|
|
1,998,040
|
|
Total cash equivalents and short-term investment securities
|
|
$
|
41,526,540
|
|
|
$
|
20,448,973
|
|
|
$
|
-
|
|
|
$
|
61,975,513
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrant liability
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
216,490
|
|
|
$
|
216,490
|
|
Money market mutual funds are valued at
their daily closing price as reported by the fund. Money market mutual funds held by the Company are open-end mutual funds that
are registered with he SEC that generally transact at a stable $1.00 Net Asset Value (“NAV”) representing its estimated
fair value. On a daily basis the fund’s NAV is determined by the fund based on the amortized cost of the funds underlying
investments.
U.S. government agency bonds, U.S. treasury
securities, and corporate bonds are valued using pricing models maximizing the use of observable inputs for similar securities.
Certificates of deposit are valued at net
present value of their expected cash flows assuming no unusual market conditions or discount for the credit worthiness of the issuer.
At December 31, 2017 cost approximated fair value.
The investment in stock warrants are measured
at fair value using the Black-Scholes pricing model and are classified within Level 3 of the valuation hierarchy. The unobservable
input is an estimated volatility factor of 92% at December 31, 2018. A 20% increase or decrease in the volatility factor used at
December 31, 2018 would have the impact of increasing or decreasing the fair value measurement of the stock warrants by approximately
$505,000.
The following table sets forth a summary of the changes in fair value of the Company’s stock warrants
(Level 3 asset) for the year ended December 31, 2018:
Fair value at December 31, 2017
|
|
$
|
-
|
|
Fair value of stock warrants acquired on August 8, 2018
|
|
|
2,807,958
|
|
Unrealized gain as a result of change in fair value
|
|
|
284,400
|
|
|
|
|
|
|
Fair value at December 31, 2018
|
|
$
|
3,092,358
|
|
The warrant liability was 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 including the volatility factor. Significant increases or decreases in the volatility factor would have resulted in
a significantly higher or lower fair value measurement. The Company’s warrants associated with the warrant liability were
exercised in July 2018 and the remaining outstanding warrants at December 31, 2018 do not include anti-dilution features and therefore
are not considered derivative instruments and do not have an associated warrant liability.
The following table sets forth a summary
of the Company’s available-for-sale securities in its short-term investment account from amortized cost basis to fair value
at December 31, 2018:
|
|
Available-for-sale Securities - December 31, 2018
|
|
|
|
Amortized
|
|
|
Gross
|
|
|
Gross
|
|
|
|
|
|
|
Cost Basis
|
|
|
Unrealized Gains
|
|
|
Unrealized Losses
|
|
|
Fair Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate bonds
|
|
$
|
38,579,541
|
|
|
$
|
48,796
|
|
|
$
|
(49,282
|
)
|
|
$
|
38,579,055
|
|
U.S. treasury securities
|
|
|
2,959,063
|
|
|
|
11,837
|
|
|
|
-
|
|
|
|
2,970,900
|
|
U.S. government agency bonds
|
|
|
4,099,321
|
|
|
|
15,691
|
|
|
|
-
|
|
|
|
4,115,012
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
45,637,925
|
|
|
$
|
76,324
|
|
|
$
|
(49,282
|
)
|
|
$
|
45,664,967
|
|
The following table sets forth a summary of
the Company’s available-for-sale securities in its short-term investment account for amortized cost basis and fair value
by contractual maturity at December 31, 2018:
|
|
Available-for-sale Securities
|
|
|
|
December 31, 2018
|
|
|
|
Amortized
|
|
|
|
|
|
|
Cost Basis
|
|
|
Fair Value
|
|
|
|
|
|
|
|
|
Due in one year or less
|
|
$
|
43,050,306
|
|
|
$
|
43,082,677
|
|
Due after one year through two years
|
|
|
2,587,619
|
|
|
|
2,582,290
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
45,637,925
|
|
|
$
|
45,664,967
|
|
NOTE 11. – NOTE PAYABLES FOR LICENSE FEES
On June 22, 2018, the Company entered into
the Second Amendment to the License Agreement (the “Second Amendment”) with North Carolina State University (“NCSU”)
that amended an original License Agreement between the Company and NCSU, dated December 8, 2015, and the First Amendment, dated
February 14, 2018, to the original License Agreement. Under the terms of the Second Amendment, the Company is obligated to pay
NCSU milestone payments totaling $1,200,000, of which amount $500,000 was payable upon execution of the Second Amendment, $400,000
will be payable on the first anniversary of the execution of the Second Amendment, and $300,000 will be payable on the second anniversary
of the execution of the Second Amendment. The Company has recorded the present value of the obligations under the Second Amendment
as a note payable that originally amounted to $1,175,226. After the initial payment of $500,000 and the accretion of interest during
year ended December 31, 2018 in the amount of $8,892, the balance remaining as of December 31, 2018 amounted to $684,117, with
$395,386 and $288,731 reported as current and long-term portion of the note payable, respectively, on the Company’s Consolidated
Balance Sheets.
The cost of the acquired license amounted
to $1,175,226 and is included in Intangible assets, net on the Company’s Consolidated Balance Sheets, and will be amortized
on a straight-line basis over the last-to-expire patent, which is expected to be in 2036.
On October 22, 2018, the Company entered
into a License Agreement with the University of Kentucky. Under the terms of the License Agreement, the Company is obligated to
pay the University of Kentucky milestone payments totaling $1,200,000, of which amount $300,000 was payable upon execution, and
$300,000 will be payable annually over the next three years on the anniversary of the execution of the License Agreement. The Company
has recorded the present value of the obligations under the License Agreement as a note payable that originally amounted to $1,151,201.
After the initial payment of $300,000 and the accretion of interest during the year ended December 31, 2018 in the amount of $2,047,
the balance remaining as of December 31, 2018 amounted to $853,248, with $293,762 and $559,486 reported as current and long-term
portion of the note payable, respectively, on the Company’s Consolidated Balance Sheets.
The cost of the of acquired licenses amounted
to $1,151,201 and is included in Intangible assets, net on the Company’s Consolidated Balance Sheets, and will be amortized
on a straight-line basis over the last-to-expire patent, which is expected to be in 2033.
NOTE 12. - WARRANTS FOR COMMON STOCK
At December 31, 2018, the Company had outstanding warrants to purchase 11,293,211 shares of common stock
of the Company that were issued in conjunction with the June 2017 warrant exchange agreements with an exercise price of $2.15 per
share and an expiration date of December 20, 2022. See Note 3 for additional details.
During the year ended December 31, 2018,
warrant holders exercised 794,869 warrants on a cashless basis, resulting in the issuance of 490,012 shares.
During the year ended December 31, 2017,
warrant holders exercised 12,763,238 warrants, with 1,286,277 of such warrants being exercised on a cashless basis, resulting in
the issuance of an aggregate of 12,249,327 shares. Additionally, 223,814 warrants expired unexercised during the year ended December
31, 2017.
The Company estimates the value of warrant
liability upon issuance of warrants that are considered derivative instruments 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. The Company’s outstanding warrants at December
31, 2018 do not include anti-dilution features and therefore are not considered derivative instruments and do not have an associated
warrant liability.
The following table is a roll-forward summary of
the warrant liability since December 31, 2016:
Fair value at December 31, 2016
|
|
$
|
58,681
|
|
Loss as a result of change in fair value
|
|
|
157,809
|
|
Fair value at December 31, 2017
|
|
|
216,490
|
|
Gain as a result of change in fair value
|
|
|
(48,711
|
)
|
Reclassification of warrant liability to capital in excess of par
|
|
|
(167,779
|
)
|
Fair value at December 31, 2018
|
|
$
|
-
|
|
The aggregate net gain (loss) as a result
of the Company’s warrant liability for the years ended December 31, 2018, 2017, and 2016 amounted to $48,711, ($157,809),
and $29,615, respectively, and are included in Other income (expense) under Warrant liability gain (loss), net in the accompanying
Consolidated Statements of Operations and Comprehensive Loss.
The following table summarizes the Company’s
warrant activity since December 31, 2016:
|
|
Number of
Warrants
|
|
Warrants outstanding at December 31, 2016
|
|
|
13,781,921
|
|
Warrants exercised during 2017
|
|
|
(1,470,027
|
)
|
Warrants expired during 2017
|
|
|
(223,814
|
)
|
Warrants issued pursuant to June 2017 warrant exercise agreements
|
|
|
11,293,211
|
|
Warrants exercised pursuant to June 2017 warrant exercise agreements
|
|
|
(11,293,211
|
)
|
Warrants outstanding at December 31, 2017
|
|
|
12,088,080
|
|
Warrants exercised during 2018
|
|
|
(794,869
|
)
|
Warrants outstanding at December 31, 2018
|
|
|
11,293,211
|
|
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, 2018, 2017, and
2016 amounted to $141,083, $98,368 and $84,499, respectively.
NOTE 14. - COMMITMENTS AND CONTINGENCIES
License agreements and sponsored research
–
The Company has entered into various license agreements and sponsored research and development agreements.
The costs associated with the following three agreements were 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 and Comprehensive Loss. The amounts expensed during the years
ended December 31, 2018, 2017, and 2016 amounted to $394,249, $232,140, and $447,808, respectively.
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 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 expensed license fees of $225,000 for each of the years ended December 31, 2018, 2017, and
2016. 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, 2018, 2017, and 2016 the aggregate
costs incurred related to capitalized patent costs and patent maintenance expense amounted to $95,602, 71,596 and $84,191, 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 royalty 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 expensed license fees of $0, $0, and $137,500 for the years
ended December 31, 2018, 2017, and 2016, respectively. The Company is also responsible for reimbursing NCSU for actual
third-party patent costs incurred. During the years ended December 31, 2018, 2017, and 2016 the aggregate costs incurred
related to capitalized patent costs and patent maintenance expense amounted to $113,578, $31,947 and $6,075, 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 had extended the Agreement through January 31, 2017 at an additional cost of $85,681. In February 2018, the Company finalized
an additional extension to this Agreement through April 30, 2018 at a cost of $88,344. In May 2018, the Company finalized an additional
extension to this Agreement through April 30, 2019 at a total cost of $121,357. The amounts expensed during the years ended December
31, 2018, 2017, and 2016 were $169,249, $7,140, and $85,308, respectively.
Other license agreements
-
Additionally, the Company has entered into the following five license agreements and the costs associated with these license
agreements 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, 2018, 2017, and 2016 amounted to $142,541, $98,022 and $98,022, respectively, and was included in Amortization
expense on the Company’s Consolidated Statements of Operations and Comprehensive Loss.
On October 22, 2018, the Company entered
into a License Agreement (the “License”) with the University of Kentucky. Under the terms of the License, the Company
is obligated to pay the University of Kentucky a non-refundable, non-creditable license fee of $1,200,000. The license fee is payable
in accordance with a note payable more fully described in Note 11. The present value of the payments in the amount of $1,151,201
are included in Intangible assets, net on the Company’s Consolidated Balance Sheets, and will be amortized on a straight-line
basis over the last-to-expire patent, which is expected to be in 2033. Amortization of the license fee began in the fourth quarter
of 2018.
On June 22, 2018, the Company entered into
the Second Amendment to the License Agreement (the “Second Amendment”) with NCSU that amended an original License Agreement
between the Company and NCSU, dated December 8, 2015. Under the terms of the Second Amendment, the Company is obligated to pay
NCSU a non-refundable, non-creditable license fee of $1,200,000. The license fee is payable in accordance with a note payable more
fully described in Note 11. The present value of the payments in the amount of $1,175,226 are included in Intangible assets, net
on the Company’s Consolidated Balance Sheets, and will be amortized on a straight-line basis over the last-to-expire patent,
which is expected to be in 2036. Amortization of the license fee began in the third quarter of 2018.
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 and
Comprehensive Loss for the year ended December 31, 2017. Additionally, under the License Agreement the Company paid NCSU a non-refundable,
non-creditable license maintenance fee in the amount of $15,000 during the year ended December 31, 2017. 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, 2018, 2017, and 2016, the aggregated costs incurred related to capitalized patent costs and
patent maintenance expense amounted to $24,016, $41,033, and $43,740, 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, a running royalty on future net sales of products made from such sublicensed intellectual property, and
a sharing of future sublicensing consideration received from sublicensing to third-parties such sublicensed intellectual property.
The Anandia Sublicense continues through the life of the last-to-expire patent, which is expected to be in 2035. As discussed in
Note 9, Anandia was purchased by Aurora on August 8, 2018 and has become a wholly-owned subsidiary of Aurora. The Anandia Sublicense
is still in effect.
Other research agreements
-
Further, the Company has entered into the following three agreements relating to sponsored research. Costs associated
with these agreements are expensed when incurred in Research and development costs on the Company’s Consolidated Statements
of Operations and Comprehensive Loss.
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 conducted research on behalf of the Company relating to the hemp/cannabis plant. During the years ended
December 31, 2018, 2017, and 2016 expenses related to the Agreement amounted to $130,850, $654,250 and $263,400, respectively.
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. As discussed in Note 9, Anandia was
purchased by Aurora on August 8, 2018 and has become a wholly-owned subsidiary of Aurora. The Agreement is still currently in effect.
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 of the United States. 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 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. The Company
incurred expenses under the agreement in the amount $360,046, $296,710 and $224,560 for the years ended December 31, 2018,
2017, and 2016, respectively.
On May 1, 2018, the Company entered into
a University Growing and Evaluation Agreement (the “Agreement”) with the University of Kentucky Research Foundation
(“UKRF”) whereby UKRF will provide the Company with services relating to growing certain tobacco breeding lines of
the Company. Under the Agreement, the Company is obligated to pay $75,000 to UKRF in three installments of $25,000 each through
January 31, 2019. During the year ended December 31, 2018 expenses related to the Agreement amounted to $50,000.
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 second two-year lease extension
term that will expire on October 31, 2019. The lease expense for the years ended December 31, 2018, 2017, and 2016 amounted to
approximately $169,000, $156,000, and $146,000, respectively. The future minimum annual lease payments if the Company exercises
each of the additional extensions are approximately as follows:
Year ended December 31, 2019 -
|
|
$
|
169,000
|
|
Year ended December 31, 2020 -
|
|
$
|
169,000
|
|
Year ended December 31, 2021 -
|
|
$
|
141,000
|
|
On August 14, 2017, the Company entered
into a lease for warehouse space in North Carolina to store and operate tobacco leaf processing equipment, to store the Company’s
proprietary tobacco leaf and to store inventory used in the Company’s contract manufacturing business. The lease calls for
a monthly payment of $4,665, expired on August 14, 2018, and contains twelve-month renewal options as long as the Company continues
to lease the warehouse. Future minimum lease payments will be approximately $56,000 per year for each subsequent year the warehouse
space is leased by the Company.
On October 4, 2017, the Company entered
into a new lease for the office space in Williamsville, New York with an initial three-year term and a monthly lease payment of
$6,375. The office space lease contains three (3) additional extensions; with each lease extension being for an additional one
(1) year in duration, exercisable at the Company’s option. Future minimum annual lease payments under the office lease will
be approximately $76,000, $76,000, and $80,000 for the years ended December 31, 2019, 2020, and 2021, respectively.
On May 1, 2016, the Company entered into
a sublease for laboratory space in Buffalo, New York. The sublease called 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 that called for the sublease of
additional lab space at a cost of $1,219 per month, bringing the total monthly sublease 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. On February 21, 2018, the Company
entered into a new sublease amendment that extended the sublease term through June 30, 2019 and called for a monthly sublease payment
of $5,706 beginning on March 1, 2018. Future minimum sublease payments for the year ended December 31, 2019 will be approximately
$34,000.
Modified Risk Tobacco Product Application
(“MRTPA”)
–
In connection with the Company’s MRTPA for its
Brand A
Very Low Nicotine Content
(“VLNC”) cigarettes with the FDA that was filed in December of 2018, the Company has entered in various contracts
with third-party service providers to fulfill various requirements of the MRTPA. Such contracts include services for clinical
trials, perception studies, legal guidance, product testing, and consulting expertise. During the year ended December 31, 2018,
the Company incurred expenses relating to these contracts in the approximate amount of $9,800,000. There were no expenses incurred
relating to this MRTPA for the years ended December 31, 2017 and 2016. Future financial commitments under these contracts are
estimated to amount to approximately an additional $1,5000,000 and are expected to be completed by the end of the second quarter
of 2019.
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.
Crede Case
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 sought 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
sought 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 as defined and contained in 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
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.
On December 28, 2017, the SDNY Court issued
its decision in response to the Company’s motion for summary judgement, with such decision (i) granting the Company’s
motion for summary judgement relating to Count II of the Amended Compliant, which eliminates Crede’s claim to rescind the
prior securities purchase agreement, dated September 17, 2014, and denies Crede’s claim for the return of any money from
the Company under that securities purchase agreement, and (ii) denying the Company’s motion for summary judgement on the
remaining Counts of the Amended Compliant. In this decision, the SDNY Court also found that Crede breached the Activity Restrictions
as defined and contained in the Tranche 1A warrant. As a result of this decision by the SDNY Court, the parties will now proceed
with discovery in the case in preparation for a trial on the remaining Counts III, IV and V of the Amended Complaint, which relate
to Crede’s claim (i) to exchange the Tranche 1A warrant for 2,077,555 shares of our common stock even though Crede breached
the Activity Restrictions contained in the Tranche 1A warrant, (ii) for an unquantified additional amount of shares of our common
stock that allegedly still remains under the Tranche 1A warrant even though Crede breached the Activity Restrictions contained
in the Tranche 1A warrant; and (iii) for alleged damages for the alleged breach of the Tranche 1A warrant in an amount in excess
of $18 million, plus costs and interest, even though Crede breached the Activity Restrictions contained in the Tranche 1A warrant.
On July 13, 2018, the SDNY Court denied
Crede’s request to extend the discovery deadline. As a result of such ruling, the discovery in the Crede case has been concluded.
On July 20, 2018, the SDNY Court granted the request by the Company to file a motion for partial summary judgment to substantially
limit the various damage claims by Crede, with the remaining schedule in the case being deferred until after the SDNY Court rules
on such motion.
The Company filed its partial summary judgment
motion on August 20, 2018, after which Crede filed its response on September 27, 2018, after which the Company filed its reply
to Crede’s response on October 11, 2018. On February 15, 2019, the SDNY Court issued its decision in response to the Company’s
motion for partial summary judgment, with such decision (i) granting the Company’s motion to limit Crede’s claims
for damages of not more than $10 million and (ii) denying the Company’s other motions seeking to further limit the damages
claims by Crede because the SDNY Court desires for the parties to present evidence on their respective positions in a bench trial
(a trial in front of the judge without a jury). The SDNY Court further ordered the parties to submit a joint letter on or before
March 1, 2019, setting forth their availability for a bench trial in the second half of 2019. On March 1, 2019, the parties
submitted such joint letter to the SDNY Court setting forth their availability for a bench trial in the second half of 2019.
The Company believes 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.
Class Action Cases
On January 21, 2019, Matthew Jackson Bull,
a resident of Denver, Colorado, filed a Complaint against the Company, the Company’s Chief Executive Officer, Henry Sicignano
III, and the Company’s Chief Financial Officer, John T. Brodfuehrer, in the United States District Court for the Eastern
District of New York entitled:
Matthew Bull, Individually and on behalf of all others similarly situated, v. 22nd Century
Group, Inc., Henry Sicignano III, and John T. Brodfuehrer,
Case No. 1:19-cv-00409
. The Complaint filing discloses
that Plaintiff Mr. Bull purchased 3,000 shares of the Company’s common stock from September 14, 2016 to October 15, 2018
at share prices between $.91 and $2.57 per share, and that on September 24, 2018, he sold 419 shares for a profit at $2.88 per
share. Mr. Bull sues individually and seeks to bring a class action for persons or entities who acquired the Company’s
common stock between February 18, 2016 and October 25, 2018, and alleges in Count I that the Company’s Annual Reports on
Form 10-K for the years 2015, 2016 and 2017 allegedly contained false statements in violation of Section 10(b) of the Securities
Exchange Act and Rule 10b-5 promulgated thereunder, and alleges in Count II that Messrs. Sicignano and Brodfuehrer are supposedly
liable for the allegedly false statements pursuant to Section 20(a) of the Securities Exchange Act. The Complaint seeks declaratory
relief, unspecified money damages, and attorney’s fees and costs. The Complaint has not yet been served on the Company, Mr.
Sicignano or Mr. Brodfuehrer and, therefore, the Company and Messrs. Sicignano and Brodfuehrer have not yet filed responses. We
believe that the claims are frivolous, meritless and that the Company and Messrs. Sicignano and Brodfuehrer have substantial legal
and factual defenses to the claims. We intend to vigorously defend the Company and Messrs. Sicignano and Brodfuehrer against such
claims.
On January 29, 2019, Ian M. Fitch, a resident
of Essex County Massachusetts, filed a Complaint against the Company, the Company’s Chief Executive Officer, Henry Sicignano
III, and the Company’s Chief Financial Officer, John T. Brodfuehrer, in the United States District Court for the Eastern
District of New York entitled:
Ian Finch, Individually and on behalf of all others similarly situated, v. 22nd Century
Group, Inc., Henry Sicignano III, and John T. Brodfuehrer,
Case No. 2:19-cv-00553
. The Complaint filing discloses
that the Plaintiff Mr. Fitch purchased 3,300 shares of the Company’s common stock on October 11, 2017 at $3.04 per share.
Mr. Fitch sues individually and seeks to bring a class action for persons or entities who acquired the Company’s common stock
between February 18, 2016 and October 25, 2018, and alleges in Count I that the Company’s Annual Reports on Form 10-K for
the years 2015, 2016 and 2017 allegedly contained false statements in violation of Section 10(b) of the Securities Exchange Act
and Rule 10b-5 promulgated thereunder, and alleges in Count II that Messrs. Sicignano and Brodfuehrer are supposedly liable for
the allegedly false statements pursuant to Section 20(a) of the Securities Exchange Act. The Complaint seeks declaratory
relief, unspecified money damages, and attorney’s fees and costs. We believe that the claims are frivolous, meritless and
that the Company and Messrs. Sicignano and Brodfuehrer have substantial legal and factual defenses to the claims. We intend to
vigorously defend the Company and Messrs. Sicignano and Brodfuehrer against such claims.
Shareholder Derivative Cases
On February 6, 2019, Melvyn Klein, a resident
of Nassau County New York, filed a shareholder derivative claim against the Company, the Company’s Chief Executive Officer,
Henry Sicignano III, the Company’s Chief Financial Officer, John T. Brodfuehrer, and each member of the Company’s Board
of Directors in the United States District Court for the Eastern District of New York entitled:
Melvyn Klein, derivatively on
behalf of 22nd Century Group v. Henry Sicignano, III, Richard M. Sanders, Joseph Alexander Dunn, Nora B. Sullivan, James W. Cornell,
John T. Brodfuehrer and 22nd Century Group, Inc.
,
Case No. 1:19-cv-00748.
Mr. Klein brings this action derivatively
alleging that (i) the director defendants supposedly breached their fiduciary duties for allegedly allowing the Company to make
false statements; (ii) the director defendants supposedly wasted corporate assets to defend this lawsuit and the other related
lawsuits; (iii) the defendants allegedly violated Section 10(b) of the Securities Exchange Act and Rule 10b-5 promulgated thereunder
for allegedly approving or allowing false statements regarding the Company to be made; and (iv) the director defendants allegedly
violated Section 14(a) of the Securities Exchange Act and Rule 14a-9 promulgated thereunder for allegedly approving or allowing
false statements regarding the Company to be made in the Company’s proxy statement. The Complaint seeks declaratory relief,
unspecified monetary damages, corrective corporate governance actions, and attorney’s fees and costs. We believe that the
claims are frivolous, meritless and that the Company and the individual defendants have substantial legal and factual defenses
to the claims. We intend to vigorously defend the Company and the individual defendants against such claims.
On February 11, 2019, Stephen Mathew filed
a shareholder derivative claim against the Company, the Company’s Chief Executive Officer, Henry Sicignano III, the Company’s
Chief Financial Officer, John T. Brodfuehrer, and each member of the Company’s Board of Directors in the Supreme Court of
the State of New York, County of Erie, entitled:
Stephen Mathew, derivatively on behalf of 22nd Century Group, Inc. v. Henry
Sicignano, III, John T. Brodfuehrer, Richard M. Sanders, Joseph Alexander Dunn, James W. Cornell, Nora B. Sullivan and 22nd Century
Group, Inc.
,
Index No. 801786/2019.
Mr. Mathew brings this action derivatively alleging that (i) the director defendants
supposedly breached their fiduciary duties for allegedly allowing the Company to make false statements; (ii) the director defendants
were allegedly unjustly enriched by allegedly benefitting from allegedly allowing the Company to make false statements; (iii) the
defendants supposedly wasted corporate assets to defend this lawsuit and the other related lawsuits; (iv) the individual defendants
allegedly abused their ability to control and influence the Company; and (v) the individual defendants allegedly engaged in gross
mismanagement. The Complaint seeks declaratory relief, unspecified monetary damages, corrective corporate governance actions, and
attorney’s fees and costs. We believe that the claims are frivolous, meritless and that the Company and the individual defendants
have substantial legal and factual defenses to the claims. We intend to vigorously defend the Company and the individual defendants
against such claims.
On February 19, 2019, the Company received
a demand letter from attorneys representing Van McClendon, a shareholder of the Company, in which Mr. McClendon demanded that the
Company’s Board of Directors take action to pursue certain purported causes of action on behalf of the Company to remedy
alleged breaches of fiduciary duties by each of the members of the Company’s Board of Directors, the Company’s Chief
Executive Officer, Henry Sicignano III, and the Company’s Chief Financial Officer, John T. Brodfuehrer.
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, 2018, 2017, and 2016:
|
|
December 31,
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2018
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
Net loss attributed to common shareholders
|
|
$
|
(7,966,911
|
)
|
|
$
|
(13,029,117
|
)
|
|
$
|
(11,581,430
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for basic earnings per share-weighted average shares outstanding
|
|
|
124,298,981
|
|
|
|
101,161,380
|
|
|
|
79,842,773
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrants, restricted stock and options outstanding
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for diluted earnings per common share-weighted average shares adjusted for dilutive securities
|
|
|
124,298,981
|
|
|
|
101,161,380
|
|
|
|
79,842,773
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss per common share - basic and diluted
|
|
$
|
(0.06
|
)
|
|
$
|
(0.13
|
)
|
|
$
|
(0.15
|
)
|
Securities outstanding that were excluded
from the computation of earnings per share for the years ended December 31, 2018, 2017, and 2016 because they would have been anti-dilutive
are as follows:
|
|
December 31,
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2018
|
|
|
2017
|
|
|
2016
|
|
Warrants
|
|
|
11,293,211
|
|
|
|
12,088,080
|
|
|
|
13,781,921
|
|
Options
|
|
|
8,672,082
|
|
|
|
8,156,691
|
|
|
|
5,650,679
|
|
|
|
|
19,965,293
|
|
|
|
20,244,771
|
|
|
|
19,432,600
|
|
NOTE 16. - EQUITY BASED COMPENSATION
On April 12, 2014, the shareholders of the
Company approved the 22nd Century Group, Inc. 2014 Omnibus Incentive Plan (the “OIP”) and the authorization of 5,000,000
shares thereunder. 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 December 31, 2018, the Company had available
1,602,115 shares remaining for future awards under the OIP.
During the year ended December 31, 2018,
the Company issued stock option awards from the OIP for 1,631,841 shares, to eligible individuals. Stock options issued to acquire
1,231,841 shares of Company common stock have vesting periods ranging from one to three years from the date of the award, and stock
options issued to acquire 400,000 shares of Company common stock are scheduled to vest upon the attainment of various milestones.
Additionally, 300,000 stock options were cancelled due to the death of the Company’s Senior Vice
President of Science and Regulatory Affairs and were added back to the remaining shares available to be rewarded under the OIP.
During the year ended December 31, 2017, the Company issued stock option awards from the OIP for 2,692,000 shares to eligible individuals
having vesting periods ranging from six months to three and one-half years 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.
For the years ended December 31, 2018, 2017,
and 2016, the Company recorded compensation expense related to stock option and restricted stock awards granted under the OIP of
$3,187,331, $941,650, and $911,382, respectively. The compensation expense for the year ended December 31, 2018 includes compensation
expense in the amount of $1,226,825 recognized in the second quarter of 2018 when 900,000 stock options vested upon of the death
of the Company’s Senior Vice President of Science and Regulatory Affairs on April 19, 2018.
As of December 31, 2018, unrecognized compensation
expense related to non-vested stock options amounted to approximately $3,071,000 which is expected to be recognized approximately
as follows: $1,110,000, $698,000 and $98,000 during 2019, 2020 and 2021, respectively. Approximately $1,165,000 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, 2018, 2017, and 2016:
|
|
2018
|
|
|
2017
|
|
|
2016
|
|
Risk-free interest rate (weighted average)
|
|
|
2.77
|
%
|
|
|
2.05
|
%
|
|
|
1.31
|
%
|
Expected dividend yield
|
|
|
0
|
%
|
|
|
0
|
%
|
|
|
0
|
%
|
Expected stock price volatility
|
|
|
90
|
%
|
|
|
90
|
%
|
|
|
90
|
%
|
Expected life of options (weighted average)
|
|
|
5.61 years
|
|
|
|
5.56 years
|
|
|
|
4.87 years
|
|
The Company estimated the expected volatility
of the Company’s stock to be 90%. 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, 2016 is as follows:
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
Average
|
|
|
|
|
|
|
|
|
Average
|
|
|
Remaining
|
|
Aggregate
|
|
|
|
Number of
Options
|
|
|
Exercise
Price
|
|
|
Contractual
Term
|
|
Intrinsic
Value
|
|
Outstanding at December 31, 2016
|
|
|
5,650,679
|
|
|
$
|
1.04
|
|
|
|
|
|
|
|
Granted in 2017
|
|
|
2,692,000
|
|
|
$
|
1.76
|
|
|
|
|
|
|
|
Exercised in 2017
|
|
|
(85,988
|
)
|
|
$
|
0.79
|
|
|
|
|
|
|
|
Expired in 2017
|
|
|
(100,000
|
)
|
|
$
|
1.43
|
|
|
|
|
|
|
|
Outstanding at December 31, 2017
|
|
|
8,156,691
|
|
|
$
|
1.28
|
|
|
|
|
|
|
|
Granted in 2018
|
|
|
1,631,841
|
|
|
$
|
2.64
|
|
|
|
|
|
|
|
Exercised in 2018
|
|
|
(612,259
|
)
|
|
$
|
0.87
|
|
|
|
|
|
|
|
Expired / cancelled in 2018
|
|
|
(504,191
|
)
|
|
$
|
1.71
|
|
|
|
|
|
|
|
Outstanding at December 31, 2018
|
|
|
8,672,082
|
|
|
$
|
1.54
|
|
|
5.8 years
|
|
$
|
8,193,642
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at December 31, 2018
|
|
|
5,202,555
|
|
|
$
|
1.37
|
|
|
4.4 years
|
|
$
|
5,498,675
|
|
The weighted average grant date fair value
of options issued during the years ended December 31, 2018 and 2017 was $1.81 and $1.28, respectively. The total fair value of
options that vested during the years ended December 31, 2018 and 2017 amounted to $2,628,622 and $750,265, respectively. There
were 612,259 options exercised on a cash and cashless basis during the year ended December 31, 2018 resulting in the issuance of
583,214 shares and proceeds of $444,614 to the Company. There were 85,988 options exercised on a cashless basis during the year
ended December 31, 2017 resulting in the issuance of 51,927 shares of the Company’s common stock.
NOTE 17. - INCOME TAXES
The TCJA was signed into law on December 22, 2017. The TCJA includes significant changes to the U.S. corporate
income tax system, including a Federal corporate rate reduction from 35% to 21%. The Company’s income tax provision (benefit)
reflects the effect of this change in Federal corporate tax rates, primarily from the re-measurement of the Company’s deferred
tax assets and liabilities, including prior net operating loss carry-forwards. The effect of the rate change attributable to the
TCJA on the Company’s effective tax rate was a decrease of approximately 46% in the net deferred tax assets before the valuation
allowance.
The following is a summary of the components
giving rise to the income tax provision (benefit) for the years ended December 31, 2018, 2017, and 2016:
|
|
2018
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
Current:
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
State
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred:
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
|
(1,446,323
|
)
|
|
|
1,263,677
|
|
|
|
(2,424,497
|
)
|
State
|
|
|
(13,927
|
)
|
|
|
214,628
|
|
|
|
21,452
|
|
Total deferred
|
|
|
(1,460,250
|
)
|
|
|
1,478,305
|
)
|
|
|
(2,403,045
|
)
|
Change in valuation allowance
|
|
|
1,460,250
|
|
|
|
(1,478,305
|
)
|
|
|
2,403,045
|
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
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, including the effect
of the change in the U.S. corporate income tax rates, as follows:
|
|
2018
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
Statutory federal rate
|
|
|
(21.0
|
)%
|
|
|
(34.0
|
)%
|
|
|
(34.0
|
)%
|
Other items
|
|
|
0.1
|
|
|
|
(2.4
|
)
|
|
|
(0.2
|
)
|
Derivative liability
|
|
|
(0.1
|
)
|
|
|
0.4
|
|
|
|
11.9
|
|
Stock based compensation
|
|
|
2.5
|
|
|
|
2.0
|
|
|
|
1.5
|
|
Research and development credit carryforward
|
|
|
(1.2
|
)
|
|
|
(1.8
|
)
|
|
|
-
|
|
State tax provision, net of federal benefit
|
|
|
(0.1
|
)
|
|
|
0.1
|
|
|
|
0.1
|
|
Equity investment
|
|
|
1.5
|
|
|
|
|
-
|
|
|
-
|
|
Federal tax rate change
|
|
|
-
|
|
|
|
46.1
|
|
|
|
-
|
|
Valuation allowance
|
|
|
18.3
|
|
|
|
(11.4
|
)
|
|
|
20.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effective tax rate (benefit) provision
|
|
|
0.0
|
%
|
|
|
0.0
|
%
|
|
|
0.0
|
%
|
Individual components of deferred taxes
consist of the following as of December 31:
|
|
2018
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net operating loss carry-forward
|
|
$
|
11,526,599
|
|
|
$
|
9,917,641
|
|
|
$
|
11,626,143
|
|
Accounts receivable reserve
|
|
|
-
|
|
|
|
-
|
|
|
|
3,499
|
|
Inventory
|
|
|
21,000
|
|
|
|
48,011
|
|
|
|
96,934
|
|
Stock-based compensation
|
|
|
813,585
|
|
|
|
388,925
|
|
|
|
282,850
|
|
Start-up expenditures
|
|
|
242,704
|
|
|
|
279,709
|
|
|
|
477,917
|
|
Research and development credit carryforward
|
|
|
326,269
|
|
|
|
232,198
|
|
|
|
-
|
|
Loss on equity investment
|
|
|
760
|
|
|
|
11,760
|
|
|
|
139,676
|
|
Accrued bonus
|
|
|
100,896
|
|
|
|
-
|
|
|
|
-
|
|
Severance liability
|
|
|
-
|
|
|
|
-
|
|
|
|
69,860
|
|
Other
|
|
|
19,605
|
|
|
|
4,272
|
|
|
|
21,423
|
|
|
|
|
13,051,418
|
|
|
|
10,882,516
|
|
|
|
12,718,302
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Machinery and equipment
|
|
|
(214,587
|
)
|
|
|
(220,888
|
)
|
|
|
(316,232
|
)
|
Patents and trademarks
|
|
|
(562,140
|
)
|
|
|
(558,760
|
)
|
|
|
(807,137
|
)
|
Gain on investment
|
|
|
(612,286
|
)
|
|
|
-
|
|
|
|
-
|
|
Accrued expense
|
|
|
(70,933
|
)
|
|
|
-
|
|
|
|
-
|
|
Other intangible assets
|
|
|
(153,307
|
)
|
|
|
(124,953
|
)
|
|
|
(138,713
|
)
|
|
|
|
(1,613,253
|
)
|
|
|
(904,601
|
)
|
|
|
(1,262,082
|
)
|
Valuation allowance
|
|
|
(11,438,165
|
)
|
|
|
(9,977,915
|
)
|
|
|
(11,456,220
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net deferred taxes
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
The Company generated a net operating loss (“NOL”) of approximately $7,700,000 for the year
ended December 31, 2018 and this NOL carryforward loss does not expire. The Company has accumulated an NOL carryforward of approximately
$46,900,000 through December 31, 2017 and this NOL carryforward begins to expire in 2031. Utilization of the NOL carryforward may
be subject to an annual limitation in the case of equity ownership changes, as defined by law. Due to the uncertainty of the Company’s
ability to generate sufficient taxable income in the future, 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.
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 evaluated its tax positions
and believes there are no uncertain tax positions as of December 31, 2018.
NOTE 18. - SELECTED QUARTERLY FINANCIAL DATA (unaudited)
Below is selected quarterly financial data
for the years ended December 31, 2018 and 2017:
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
June 30,
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2018
|
|
|
2018
|
|
|
2018
|
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue, net
|
|
$
|
6,116,309
|
|
|
$
|
6,914,913
|
|
|
$
|
6,260,158
|
|
|
$
|
7,134,967
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
$
|
71,578
|
|
|
$
|
161,714
|
|
|
$
|
150,949
|
|
|
$
|
514,746
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
$
|
(4,968,772
|
)
|
|
$
|
(7,040,512
|
)
|
|
$
|
(6,208,834
|
)
|
|
$
|
(5,800,509
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
1,386,488
|
|
|
$
|
(6,738,652
|
)
|
|
$
|
6,304,654
|
|
|
$
|
(8,919,401
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) per common share - basic
|
|
$
|
0.01
|
|
|
$
|
(0.05
|
)
|
|
$
|
0.05
|
|
|
$
|
(0.07
|
)
|
Income (loss) per common share - diluted
|
|
$
|
0.01
|
|
|
$
|
(0.05
|
)
|
|
$
|
0.04
|
|
|
$
|
(0.07
|
)
|
|
|
Three Months Ended
|
|
|
|
March 31,
2017
|
|
|
June 30,
2017
|
|
|
September 30,
2017
|
|
|
December 31,
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue, net
|
|
$
|
2,231,517
|
|
|
$
|
3,897,206
|
|
|
$
|
4,530,865
|
|
|
$
|
5,940,656
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit (loss)
|
|
$
|
(273,897
|
)
|
|
$
|
(165,055
|
)
|
|
$
|
(340,369
|
)
|
|
$
|
71,409
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
$
|
(2,969,949
|
)
|
|
$
|
(3,282,525
|
)
|
|
$
|
(3,274,081
|
)
|
|
$
|
(3,773,309
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(2,621,277
|
)
|
|
$
|
(3,355,624
|
)
|
|
$
|
(3,316,634
|
)
|
|
$
|
(3,735,582
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss per common share - basic and diluted
|
|
$
|
(0.03
|
)
|
|
$
|
(0.04
|
)
|
|
$
|
(0.03
|
)
|
|
$
|
(0.03
|
)
|
Item 15(b).
|
Financial Statement Schedules
|
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:
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.
†† 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.