Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements
for the past 90 days.
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions
of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging
growth company” in Rule 12b-2 of the Exchange Act.
If an emerging growth company, indicate by check mark if the
registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards
provided pursuant to Section 13(a) of the Exchange Act.
¨
Indicate by check mark whether the registrant is a shell company
(as defined in Rule 12b-2 of the Exchange Act).
As of May 7, 2019, there were 124,660,000 shares of common stock issued and outstanding.
See accompanying notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2019
(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 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 three months ended
March 31, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019. The balance
sheet as of December 31, 2018 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, 2018 audited consolidated financial statements and the notes thereto contained
in our Annual Report on Form 10-K for the year ended December 31, 2018, as filed with the Securities and Exchange Commission on
March 6, 2019.
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 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 4, and performs research and development related
to the Company’s hemp business.
Reclassifications
-
Certain items in the 2018 financial statements have been reclassified
to conform to the 2019 classification.
Preferred stock authorized
-
The Company is authorized to issue “blank check” preferred stock, which could be issued with voting, liquidation,
dividend and other rights superior to our common stock.
Concentration of Credit Risk
-
Financial instruments that
potentially subject the Company to concentration of credit risk consist of cash accounts in financial institutions. Although the
cash accounts exceed the federally insured deposit amount, management does not anticipate nonperformance by the financial institutions.
Management reviews the financial viability of these institutions on a periodic basis.
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. However, the Company has elected to classify money market mutual funds as short-term investment securities. 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. All of the Company’s short-term investment securities are fixed-income debt instruments, and accordingly,
all unrealized gains and losses incurred on the short-term investment securities (the adjustment to fair value) are recorded in
other comprehensive income or loss on the Company’s Consolidated Statements of Operations and Comprehensive Income (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 Income (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 March 31, 2019 and December 31, 2018
.
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 March 31, 2019 and December 31, 2018 consisted of the following:
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2019
|
|
|
2018
|
|
Inventory - tobacco leaf
|
|
$
|
1,688,619
|
|
|
$
|
1,556,581
|
|
Inventory - finished goods
|
|
|
|
|
|
|
|
|
Cigarettes and filtered cigars
|
|
|
182,564
|
|
|
|
156,702
|
|
Inventory - raw materials
|
|
|
|
|
|
|
|
|
Cigarette and filtered cigar components
|
|
|
1,563,212
|
|
|
|
1,430,666
|
|
|
|
|
3,434,395
|
|
|
|
3,143,949
|
|
Less: inventory reserve
|
|
|
100,000
|
|
|
|
100,000
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
3,334,395
|
|
|
$
|
3,043,949
|
|
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.
Right-of-use assets
-
On
January 1, 2019, the Company adopted ASU 2016-02, Subtopic ASC 842, Leases, and as a result has recorded Right-to-use assets and
corresponding Lease obligations as more fully discussed in Note 3.
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 March 31, 2019 and December 31, 2018 consisted of the following:
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2019
|
|
|
2018
|
|
Intangible assets, net
|
|
|
|
|
|
|
|
|
Patent and trademark costs
|
|
$
|
7,323,729
|
|
|
$
|
7,136,774
|
|
Less: accumulated amortization
|
|
|
3,350,577
|
|
|
|
3,194,565
|
|
Patent and trademark costs, net
|
|
|
3,973,152
|
|
|
|
3,942,209
|
|
|
|
|
|
|
|
|
|
|
License fees, net (see Note 8)
|
|
|
3,776,426
|
|
|
|
3,776,426
|
|
Less: accumulated amortization
|
|
|
528,678
|
|
|
|
469,131
|
|
License fees, net
|
|
|
3,247,748
|
|
|
|
3,307,295
|
|
|
|
|
|
|
|
|
|
|
MSA signatory costs
|
|
|
2,202,000
|
|
|
|
2,202,000
|
|
|
|
|
|
|
|
|
|
|
License fee for predicate cigarette brand
|
|
|
300,000
|
|
|
|
300,000
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
9,722,900
|
|
|
$
|
9,751,504
|
|
Amortization expense relating to the above
intangible assets for the three months ended March 31, 2019 and 2018 amounted to $215,559 and $167,552, respectively.
The estimated annual average amortization
expense for the next five years is approximately $460,000 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
three months ended March 31, 2019 and 2018, respectively
.
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 losses and credit carry-forwards.
As a result of 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 March 31, 2019 and December 31, 2018. Additionally, because the Company has
a full valuation allowance offsetting its deferred tax assets and as a result has an effective tax rate of zero, the Company has
elected to present other comprehensive income items relating to net unrealized gains on short-term investment securities gross
and not net of taxes.
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 were no pending audits as of March 31, 2019.
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 or risks of forfeiture expiring.
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
daily and, therefore, there were no performance obligations partially satisfied at March 31, 2019. For the contract 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 March 31, 2019 and December 31, 2018.
The Company generally requires a down payment
from its customers prior to commencement of manufacturing a 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 three months ended March 31, 2019 and 2018, net sales revenue from products transferred over time amounted to approximately
$4,215,000 and $3,923,000, respectively, and net sales revenue from products transferred at a point in time amounted to approximately
$2,079,000 and $2,193,000, respectively.
Derivatives
-
The
Company does not use derivative instruments to hedge exposures to cash flow, market or foreign currency risks. The Company
evaluates its 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
Income (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 $5,000 and $12,000 for the three months
ended March 31, 2019 and 2018, respectively.
(Loss) Income Per Common Share -
Basic
income (loss) per common share is computed using the weighted-average number of common shares outstanding. Diluted income
(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, investment (stock warrants), accounts payable, accrued expenses, and notes payable. Other than for cash equivalents,
short-term investment securities, and investment (stock warrants), 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, and investment (stock warrants) are discussed in Note 6.
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
former investment in Anandia Laboratories, Inc. in Canada (see Note 4 for a further discussion).
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 Income (Loss).
NOTE 2. - MACHINERY AND EQUIPMENT
Machinery and equipment at March 31, 2019
and December 31, 2018 consisted of the following:
|
|
Useful Life
|
|
March 31,
2019
|
|
|
December 31,
2018
|
|
Cigarette manufacturing equipment
|
|
3 - 10 years
|
|
$
|
4,683,035
|
|
|
$
|
4,608,267
|
|
Office furniture, fixtures and equipment
|
|
5 years
|
|
|
143,062
|
|
|
|
135,909
|
|
Laboratory equipment
|
|
5 years
|
|
|
120,768
|
|
|
|
104,709
|
|
Leasehold improvements
|
|
6 years
|
|
|
215,446
|
|
|
|
169,362
|
|
|
|
|
|
|
5,162,311
|
|
|
|
5,018,247
|
|
Less: accumulated depreciation
|
|
|
|
|
1,829,260
|
|
|
|
1,757,499
|
|
Machinery and equipment, net
|
|
|
|
$
|
3,333,051
|
|
|
$
|
3,260,748
|
|
Depreciation expense was $135,047 and $124,528
for the three months ended March 31, 2019 and March 31, 2018, respectively.
NOTE 3. - RIGHT-OF-USE ASSETS, LEASE OBLIGATIONS,
AND OTHER LEASES
On January 1, 2019, the Company adopted ASU
2016-02, Subtopic ASC 842, Leases (the “new guidance”). Under the new guidance, the Company was required to evaluate
its leases and record a Right-to-use (“ROU”) asset and a corresponding Lease obligation for leases that qualified as
either finance or operating leases. Prior to the adoption of the new guidance, the Company had various operating leases for real
estate. The Company elected to use the practical expedient which allowed the Company to carry forward the historical lease classifications
of the existing leases. The Company determined that its leases contained (1) no variable lease expenses, (2) no termination options,
(3) no residual lease guarantees, and (4) no material restrictions or covenants. The new guidance calls for the Lease obligations
to be recorded at the present value of the remaining lease payments under the leases and the ROU assets are recorded as the sum
of the present value of the Lease obligations plus any initial direct costs minus lease incentives plus prepaid lease payments.
All remaining renewal options have been included in the computation of the ROU assets and Lease obligations. The present value
of the remaining lease payments was computed using a discount rate of 5.14%. The Company determined that two real estate leases
qualified as operating leases under the new guidance as discussed below.
The Company leases a manufacturing facility
and warehouse located in North Carolina on a triple net lease basis with a monthly lease payment of $14,094. As of January 1, 2019,
the lease had a remaining term of thirty-four (34) months including all renewal options. The lease expense for the three months
ended March 31, 2018 amounted to approximately $42,000. Under the new guidance , the Company recorded a ROU asset and a corresponding
Lease obligation in the amount of $446,950 on January 1,2019 and recorded a lease expense for the three months ended March 31,
2019 of approximately $42,000.
On October 4, 2017, the Company entered a lease for office space at a location in Williamsville, New York
with an initial monthly lease payment of $6,375 per month for the first three years of the lease. The monthly lease payment increases
by 5% annually for the remainder of the lease. As of January 1, 2019, the lease had a remaining term of sixty-two (62) months including
all renewal options. The lease expense for the three months ended March 31, 2018 amounted to $6,375. Under the new guidance, the
Company recorded a ROU asset and a corresponding Lease obligation in the amount of $367,325 on January 1, 2019 and recorded a Lease
expense for the three months ended March 31, 2019 of approximately $20,000.
As a result of the new guidance, the Company
initially recorded ROU assets and Lease obligations in the amount of $814,275 on January 1, 2019 on the Company’s Consolidated
Balance Sheets. After amortizing the ROU assets and applying principal payments to the Lease obligations, the ROU assets and the
Lease obligations each had a balance of $759,596 at March 31, 2019, with $211,519 and $548,077 of the Lease obligations recorded
as current and long-term at March 31, 2019, respectively.
Further, FASB issued ASU 2018-11, Re-Leases
Targeted Improvements to ASC 842, to provide entities with relief from the costs of implementing certain aspects of the new guidance.
Under ASU 2018-11, entities may elect not to recast comparative periods when transitioning to the new guidance. The Company has
adopted ASU 2018-11, and accordingly, will (1) apply ASC 840 Lease Accounting (the “old guidance”) in comparative periods,
(2) provide disclosures for all comparative periods presented in accordance with the old guidance, and (3) recognize the effects
of applying the new guidance as a cumulative-effects adjustment to retained earnings as of January 1, 2019. No cumulative-effects
adjustment was made as the Company determined it to be immaterial.
In addition, the Company has two leases that
did not qualify as operating or financing leases under the new guidance as discussed below.
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, expires on August 14, 2019, and contains twelve-month renewal options if the Company continues to
lease the warehouse under its current terms.
On May 1, 2016, the Company entered into
a sublease for laboratory space in Buffalo, New York. After a series of sublease amendments that increased the
subleased laboratory space and monthly sublease payment, the Company on February 21, 2018 entered into a new sublease
amendment that further increased the lab space, extended the sublease term through June 30, 2019 and called for a monthly
sublease payment of $5,706 beginning on March 1, 2018. The lease expense for the three months ended March 31, 2019 and 2018
amounted to approximately $17,000 and 11,000, respectively.
The Company is currently in discussions with
the lessors of the above two leases concerning new leases for these facilities. Any new leases that may result from these discussions
will be evaluated under the new lease guidance.
NOTE 4. – INVESTMENT
The Company (through its wholly-owned subsidiary,
Botanical Genetics) held an equity investment in Anandia Laboratories, Inc. (“Anandia”), a Canadian plant biotechnology
company. On August 8, 2018, all of Anandia’s outstanding common stock was acquired by Aurora Cannabis, Inc. (“Aurora”),
a Canadian company (TSX: ACB.TO), and as a result the Company received in exchange for its Anandia equity: (i) 1,947,943 free trading
shares of Aurora common stock, and (ii) a stock warrant to purchase 973,971 shares of Aurora common stock. The Company sold all
the shares of Aurora common stock during the third quarter of 2018, but still retains ownership of the stock warrant to purchase
973,971 shares of Aurora common stock as of March 31, 2019. The stock warrant has a five-year contractual term, an exercise price
of $9.37 per share (Canadian Dollars; approximately $7.01 per share U.S. Dollars at March 31, 2019), is currently exercisable,
is considered an equity security, and is recorded at fair value (Level 3 of the valuation hierarchy). The Company recorded the
fair value of the Aurora common stock warrant of $6,065,891 and $3,092,358 at March 31, 2019 and December 31, 2018, respectively,
using the Black-Scholes pricing model and was classified within Other assets on the Company’s Consolidated Balance Sheets.
The Company recorded an unrealized gain, the adjustment to fair value, in the amount of $2,973,533 for the three months ended March
31, 2019.
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 changed 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, as discussed above.
NOTE 5. – 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 March 31, 2019 and December 31, 2018, 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 March 31, 2019
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term investment securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money market funds
|
|
$
|
13,838,984
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
13,838,984
|
|
Corporate bonds
|
|
|
-
|
|
|
|
31,308,838
|
|
|
|
-
|
|
|
|
31,308,838
|
|
U.S. treasury securities
|
|
|
-
|
|
|
|
1,982,187
|
|
|
|
-
|
|
|
|
1,982,187
|
|
U.S. government agency bonds
|
|
|
-
|
|
|
|
4,133,886
|
|
|
|
-
|
|
|
|
4,133,886
|
|
Total short-term investment securities
|
|
$
|
13,838,984
|
|
|
$
|
37,424,911
|
|
|
$
|
-
|
|
|
$
|
51,263,895
|
|
Investment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock warrant
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
6,065,891
|
|
|
$
|
6,065,891
|
|
|
|
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
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock warrant
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
3,092,358
|
|
|
$
|
3,092,358
|
|
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 the 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.
The investment in the Aurora stock
warrant is measured at fair value using the Black-Scholes pricing model and is classified within Level 3 of the valuation
hierarchy. The unobservable input is an estimated volatility factor of 85% and 92% at March 31, 2019 and December 31, 2018,
respectively. A 20% increase or decrease in the volatility factor used at March 31, 2019 would have the impact of increasing
or decreasing the fair value measurement of the stock warrants by approximately $691,000.
The following table sets forth a summary
of the changes in fair value of the Company’s stock warrant (Level 3 asset) since December 31, 2017:
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
|
|
Unrealized gain as a result of change in fair value
|
|
|
2,973,533
|
|
Fair value at March 31, 2019
|
|
$
|
6,065,891
|
|
The following tables 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 March 31, 2019 and December 31, 2018:
|
|
Available-for-Sale Securities – March 31, 2019
|
|
|
|
Amortized
|
|
|
Gross
|
|
|
Gross
|
|
|
|
|
|
|
Cost
|
|
|
Unrealized
|
|
|
Unrealized
|
|
|
Fair
|
|
|
|
Basis
|
|
|
Gains
|
|
|
Losses
|
|
|
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate bonds
|
|
$
|
31,174,276
|
|
|
$
|
149,833
|
|
|
$
|
(15,271
|
)
|
|
$
|
31,308,838
|
|
U.S. treasury securities
|
|
|
1,967,031
|
|
|
|
15,156
|
|
|
|
-
|
|
|
|
1,982,187
|
|
U.S. government agency bonds
|
|
|
4,099,321
|
|
|
|
34,565
|
|
|
|
-
|
|
|
|
4,133,886
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
37,240,628
|
|
|
$
|
199,554
|
|
|
$
|
(15,271
|
)
|
|
$
|
37,424,911
|
|
|
|
Available-for-Sale Securities – December 31, 2018
|
|
|
|
Amortized
|
|
|
Gross
|
|
|
Gross
|
|
|
|
|
|
|
Cost
|
|
|
Unrealized
|
|
|
Unrealized
|
|
|
Fair
|
|
|
|
Basis
|
|
|
Gains
|
|
|
Losses
|
|
|
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 March 31, 2019 and December 31, 2018:
|
|
Available-for-Sale Securities
|
|
Available-for-Sale Securities
|
|
|
March 31, 2019
|
|
December 31, 2018
|
|
|
Amortized
|
|
|
|
|
Amortized
|
|
|
|
|
|
Cost Basis
|
|
Fair Value
|
|
Cost Basis
|
|
Fair Value
|
|
|
|
|
|
|
|
|
|
Due in one year or less
|
|
$
|
32,512,234
|
|
|
$
|
32,664,641
|
|
|
$
|
43,050,306
|
|
|
$
|
43,082,677
|
|
Due after one year through two years
|
|
|
4,728,394
|
|
|
|
4,760,270
|
|
|
|
2,587,619
|
|
|
|
2,582,290
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
37,240,628
|
|
|
$
|
37,424,911
|
|
|
$
|
45,637,925
|
|
|
$
|
45,664,967
|
|
NOTE 6. – NOTES PAYABLE FOR LICENSE FEE
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. The cost of the of 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.
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.
After the accretion of interest during
the three months ended March 31, 2019 in the amount of $10,660, the balance remaining on these two notes payable as of March 31,
2019 amounted to $1,548,025, with $698,048 and $849,977 reported as current and long-term, respectively, on the Company’s
Consolidated Balance Sheets (notes payable balance of $1,537,365 as of December 31, 2018, with $689,148 and $848,217 reported
as current and long-term, respectively).
NOTE 7. - WARRANTS FOR COMMON STOCK
At March 31, 2019, the Company had outstanding
warrants to purchase 11,293,211 shares of common stock of the Company with an exercise price of $2.15 per share and an expiration
date of December 20, 2022.
The Company’s outstanding warrants
at March 31, 2019 do not include anti-dilution features and therefore are not considered derivative instruments and do not have
an associated warrant liability.
The following table summarizes the Company’s
warrant activity since December 31, 2017:
|
|
Number of
Warrants
|
|
Warrants outstanding at December 31, 2017
|
|
|
12,088,080
|
|
Warrants exercised during 2018
|
|
|
(794,869
|
)
|
Warrants outstanding at March 31, 2019 and December 31, 2018
|
|
|
11,293,211
|
|
There were no warrants issued
or exercised in the first quarter of 2019.
NOTE 8. - 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 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 and Comprehensive Income (Loss). The amounts expensed during
the three months ended March 31, 2019 and 2018 were $86,589 and $137,232, 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 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 months ended March 31, 2019 and 2018, the aggregate
costs incurred related to capitalized patent costs and patent maintenance expense amounted to $4,557 and $29,262, 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. The License calls for the Company to pay NCSU a non-refundable,
non-creditable minimum annual royalty in the amount of $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 months ended March 31, 2019 and 2018, the aggregate costs incurred related to capitalized patent costs
and patent maintenance expense amounted to $4,256 and $0, respectively. This License continues through the life of the last-to-expire
patent, expected to be in 2036.
On February 10, 2014, the Company entered
into a sponsored research and development agreement (the “Agreement”) with NCSU. 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 three months ended
March 31, 2019 and 2018 were $30,339 and $80,982, 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 amounted to $59,547
and $24,506 for the three months ended March 31, 2019 and 2018, respectively, and was included in Amortization expense on the Company’s
Consolidated Statements of Operations and Comprehensive Income (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 6 –
Notes Payable for License Fee. 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.
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 6 – Notes Payable for License Fee.
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.
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. The
Company is obligated to pay to NCSU an annual minimum royalty fee of $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 months ended March 31, 2019 and 2018, the aggregate costs incurred related to capitalized patent costs and patent
maintenance expense amounted to $7,676 and $4,470, 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 4, 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 Income (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 three months ended March 31, 2019 and 2018, expenses related to the Agreement amounted to
$0 and $130,850, 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 4, Anandia was purchased by Aurora Cannabis Inc. on August 8, 2018 and has become a wholly-owned subsidiary of Aurora Cannabis
Inc. 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. During the three months ended March 31, 2019 and 2018, expenses related to the agreements amounted to
$74,534 and $103,967, 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 three months ended March 31, 2019 and 2018, expenses related to the Agreement amounted to $25,000
and $0, respectively.
On February 1, 2019, the Company entered into a Master Collaboration and Research Agreement (the “Agreement”)
with a Natural Good Medicines, LLC (“NGM”), the owners of certain hemp and cannabis plant lines (the “NGM Material”).
The Agreement calls for NGM to cultivate, grow and process a certain amount of the NGM Material with the financial support of the
Company. NGM has granted the Company certain exclusive rights to the hemp and cannabis plant lines of NGM. Additionally, three
(3) years from the effective date of the Agreement, NGM and the Company will mutually share in the proceeds from the sale of non-propagating
parts of the NGM Material. The Company’s total financial commitment under the Agreement is $403,000 which has been included
in Research and development expenses on the Company’s Statements of Operations and Comprehensive Income (Loss) for the three
months ended March 31, 2019.
Modified Risk Tobacco
Product Application (“MRTP Application”)
–
In connection with the Company’s MRTP Application
for its
Brand A
Very Low Nicotine Content (“VLNC”) cigarettes with the FDA, the Company has entered in
various contracts with third-party service providers to fulfill various requirements of the MRTP Application. Such contracts
include services for clinical trials, perception studies, legal guidance, product testing, and consulting expertise. During
the three months ended March 31, 2019 and 2018, the Company incurred expenses relating to these contracts in the approximate
amount of $1,211,000 and $1,296,000, respectively. Future financial commitments under these contracts are estimated to amount
to approximately an additional $400,000 and are expected to be completed over the next three months.
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 related expenses. 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 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 office is 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 issued 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 eliminated Crede’s claim to rescind the prior securities purchase agreement, dated September 17,
2014, and denied 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 then proceeded 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 alleges 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 $0.91 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 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
alleges 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 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.
On March 25, 2019, Plaintiffs’
counsel in the
Fitch
litigation filed a motion: (1) substituting Joseph Noto, Garden State Tire Corp, and Stephens Johnson
for Mr. Fitch as purportedly representative plaintiffs, (2) moving to consolidate the litigation with the
Bull
litigation,
and (3) seeking to be appointed as lead counsel in the consolidated action. Plaintiffs’ counsel in the
Bull
litigation
filed and then withdrew a comparable motion seeking to consolidate the cases and be appointed as lead counsel. The motion in the
Fitch
litigation remains pending.
Neither the Company nor
Messrs. Sicignano or Brodfuehrer have been served with the Complaint or proposed Amended Complaint in this case. 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. Once served with the Amended Complaint, 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
April 11, 2019, pursuant to a stipulation from the parties, the Court ordered this litigation stayed and transferred the stayed
action to the Western District of New York.
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 April 12, 2019, the parties jointly filed a Stipulated Notice of Removal
in United States District Court for the Western District of New York. On the same date, the parties also filed a joint stipulation
staying the litigation. On April 23, 2019, the parties jointly filed an Amended Stipulated Notice of Removal in the Western District
of New York.
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. On February 28, 2019,
the Board appointed a Special Committee of independent directors and instructed the Committee to assess whether pursuing the claims
detailed in the demand letter would be in the best interests of the Company.
NOTE 9. - (LOSS) INCOME PER COMMON SHARE
The following table sets forth the computation
of basic and diluted (loss) income per common share for the three-month periods ended March 31, 2019 and 2018, respectively:
|
|
March 31,
2019
|
|
|
March 31,
2018
|
|
|
|
|
|
|
|
|
Net (loss) income attributed to common shareholders
|
|
$
|
(2,072,713
|
)
|
|
$
|
1,386,488
|
|
|
|
|
|
|
|
|
|
|
Denominator for basic (loss) income per share-weighted average shares outstanding
|
|
|
124,644,721
|
|
|
|
124,019,946
|
|
|
|
|
|
|
|
|
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
Warrants and options outstanding
|
|
|
-
|
|
|
|
20,144,492
|
|
|
|
|
|
|
|
|
|
|
Denominator for diluted (loss) income per common share-weighted average shares adjusted for dilutive securities
|
|
|
124,644,721
|
|
|
|
144,164,438
|
|
|
|
|
|
|
|
|
|
|
Net (loss) income per common share - basic
|
|
$
|
(0.02
|
)
|
|
$
|
0.01
|
|
Net (loss) income per common share - diluted
|
|
$
|
(0.02
|
)
|
|
$
|
0.01
|
|
Dilutive securities outstanding at March
31, 2019 and 2018, respectively, are presented below. Securities outstanding at March 31, 2019 were excluded from the computation
of income (loss) per share because they would have been anti-dilutive.
|
|
March 31,
2019
|
|
|
March 31,
2018
|
|
Warrants
|
|
|
11,293,211
|
|
|
|
11,387,932
|
|
Options
|
|
|
8,627,582
|
|
|
|
8,756,560
|
|
|
|
|
19,920,793
|
|
|
|
20,144,492
|
|
NOTE 10. – 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 the authorization of 5,000,000
shares to be reserved for issuance thereunder. On April 29, 2017, the stockholders approved an amendment to the OIP to increase
the number of shares available for issuance by an additional 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 the OIP and the number of shares of common stock to underlie each such award under the OIP. As of March
31, 2019, the Company had available 975,115 shares remaining for future awards under the OIP.
During the three months ended March 31,
2019, the Company issued awards for restricted stock units from the OIP for 633,000 shares to eligible individuals, with such restricted
stock unit awards having vesting periods ranging from one to three years. During the three months ended March 31, 2018, the Company
issued stock option awards from the OIP for 1,131,841 shares to eligible individuals, with such stock option awards having vesting
periods ranging from one to three years. All restricted stock units are valued based on the stock price of the Company’s
common stock on the date of the award and all stock option awards were valued using the Black-Scholes option-pricing model on the
date of the award.
For the three months ended March 31, 2019
and 2018, the Company recorded compensation expense related to stock option awards granted under the OIP of $448,905 and $563,876,
respectively.
As of March 31, 2019, unrecognized compensation
expense related to non-vested stock options amounted to approximately $4,134,000, which is expected to be recognized as follows:
approximately $1,312,000, $1,125,000, $470,000 and $62,000 during 2019, 2020, 2021 and 2022, 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 milestones.
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 three months ended
March 31, 2019 and 2018:
|
|
2019
|
|
|
2018
|
|
Risk-free interest rate (weighted average)
|
|
|
n/a
|
|
|
|
2.67
|
%
|
Expected dividend yield
|
|
|
n/a
|
|
|
|
0
|
%
|
Expected stock price volatility
|
|
|
n/a
|
|
|
|
90
|
%
|
Expected life of options (weighted average)
|
|
|
n/a
|
|
|
|
5.45 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, 2017 is as follows:
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
Average
|
|
|
|
|
|
|
|
|
Average
|
|
|
Remaining
|
|
Aggregate
|
|
|
|
Number of
|
|
|
Exercise
|
|
|
Contractual
|
|
Intrinsic
|
|
|
|
Options
|
|
|
Price
|
|
|
Term
|
|
Value
|
|
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
|
|
|
|
|
|
|
|
Exercised in Q1 2019
|
|
|
(35,000
|
)
|
|
$
|
0.95
|
|
|
|
|
|
|
|
Forfeited in Q1 2019
|
|
|
(9,500
|
)
|
|
$
|
2.76
|
|
|
|
|
|
|
|
Outstanding at March 31, 2019
|
|
|
8,627,582
|
|
|
$
|
1.54
|
|
|
5.5 years
|
|
$
|
3,703,254
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at March 31, 2019
|
|
|
6,050,841
|
|
|
$
|
1.48
|
|
|
4.5 years
|
|
$
|
2,724,825
|
|
The weighted average grant date fair value
of stock options issued during the three months ended March 31, 2018 was $1.82. There were no stock options issued during the three
months ended March 31, 2019. The total fair value of options that vested during the three months ended March 31, 2019 and 2018
amounted to $1,188,374 and $235,715, respectively. There were 35,000 options exercised on a cashless basis during the three months
ended March 31, 2019 resulting in the issuance of 17,407 shares of the Company’s common stock. There were 327,781 options
exercised on a cash and cashless basis during the three months ended March 31, 2018 resulting in the issuance of 315,540 shares
of the Company’s common stock and provided proceeds to the Company of $217,500 from such stock option exercises.
NOTE 11. – SUBSEQUENT EVENTS
On April 3, 2019, the Company entered into
a Framework Collaborative Research Agreement (the “Agreement”) with KeyGene N.V. (“KeyGene”) under which
KeyGene has agreed to work exclusively with the Company with respect to the
Cannabis Sativa L
. plant and all uses thereof
(the “Field”) for an initial term of five (5) years and an option for an additional two (2) years in consideration
of the Company paying KeyGene an aggregate of Six Million United States Dollars ($6,000,000) over the initial term of the Agreement,
with a portion of such amount being contingent on KeyGene achieving certain milestone deliverables for the Company. The Company
will exclusively own all results and all intellectual property relating to the results from this collaboration with KeyGene (“Results”).
The Company will pay royalties in varying amounts to KeyGene relating to the Company’s commercialization in the Field of
certain Results. The Company has granted KeyGene a license to commercialize the Results outside of the Field and KeyGene will
pay royalties in varying amounts to the Company relating to KeyGene’s commercialization outside of the Field of the Results.
The Agreement also includes customary termination provisions for both KeyGene and the Company as well as representations, warranties,
and covenants by the parties that are customary for a transaction of this nature.
On May 3, 2019, the Company’s stockholders approved an amendment to the OIP to increase the number of
shares available for issuance by an additional 5,000,000 shares.
Item 2. Management’s Discussion and Analysis of Financial
Condition and Results of Operations
Forward Looking Statements
This Quarterly Report on Form 10-Q contains “forward-looking
statements” that reflect, when made, the Company’s expectations or beliefs concerning future events that involve risks
and uncertainties. Forward-looking statements frequently are identified by the words “believe,” “anticipate,”
“expect,” “estimate,” “intend,” “project,” “will be,” “will
continue,” “will likely result,” or other similar words and phrases. Similarly, statements herein that describe
the Company’s objectives, plans or goals also are forward-looking statements. Actual results could differ materially from
those projected, implied or anticipated by the Company’s forward-looking statements. Some of the factors that could cause
actual results to differ include: our ability to monetize our intellectual property portfolio; our ability to achieve profitability;
our ability to manage our growth effectively; the lack of implementation of the plan by the FDA to regulate nicotine content in
cigarettes; our ability to obtain FDA clearance for our Modified Risk Tobacco Product
; our ability to gain market
acceptance for our products; our ability to prevail in litigation; and our ability to maintain our rights to our intellectual
property licenses. For a discussion of these and all other known risks and uncertainties that could cause actual results to differ
from those contained in the forward-looking statements, see “Risk Factors” in the Company’s Annual Report on
Form 10-K for the year ended December 31, 2018, which is available on the SEC’s website at www.sec.gov. All forward-looking
statements are qualified in their entirety by this cautionary statement, and the Company undertakes no obligation to revise or
update this Quarterly Report on Form 10-Q to reflect events or circumstances after the date hereof.
For purposes of this Management’s
Discussion and Analysis of Financial Condition and Results of Operations, references to the “Company,” “we,”
“us” or “our” refer to the operations of 22nd Century Group, Inc. and its direct and indirect subsidiaries
for the periods described herein.
Overview
We are a plant biotechnology company focused
on (i) developing reduced risk tobacco cigarettes and smoking cessation products produced from modifying the nicotine content
in tobacco plants through genetic engineering and plant breeding, and (ii) research and development of unique hemp/cannabis plants
through genetic engineering and plant breeding to alter levels of cannabinoids to be used for potential new medicines and to improve
other agronomic traits for improved agricultural applications. We have an extensive intellectual property portfolio of issued
patents and patent applications relating to the tobacco and hemp/cannabis plants. Our management team is focused on monetizing
our intellectual property portfolio; facilitating the timely implementation of the plan by the U.S. Food and Drug Administration
(“FDA”) to require that
all
combustible cigarettes sold in the United States contain only minimally or non-addictive
levels of nicotine; working to obtain a reduced exposure marketing authorization from the FDA for our Modified Risk Tobacco Product
(“MRTP”) application to the FDA for our
BRAND A
Very Low Nicotine Content (“VLNC”) cigarettes to
be marketed in the United States under the proposed brand name of “VLN
TM”
cigarettes as containing 95%
less nicotine than conventional tobacco cigarettes, and other related claims as may be approved by the FDA; seeking licensing
agreements for our tobacco technology and/or our proprietary tobaccos; establishing international strategic partnerships to sell
and distribute our proprietary tobacco and products; and developing and commercializing unique plant varieties of hemp for important
new medicines and agricultural crops.
In tobacco, we have developed proprietary
VLNC tobacco that grows with at least 95% less nicotine than conventional cigarette tobacco. We collectively refer to all of our
various types of VLNC tobacco under the Company’s trademark name: VLN
TM
tobacco, which is also the proposed brand
name of the product that is the subject of our MRTP application with the FDA. In the year 2011, 22nd Century developed its SPECTRUM
®
research cigarettes in collaboration with independent researchers and officials from the FDA, the National Institute on Drug Abuse
(“NIDA”), which is part of the National Institutes of Health (“NIH”), the National Cancer Institute (“NCI”),
and the Centers for Disease Control and Prevention (“CDC”). Since 2011, we have produced more than 28 million SPECTRUM
®
research cigarettes containing our proprietary VLN
TM
tobaccos for use in independent clinical studies sponsored by agencies
of the U.S federal government. The main SPECTRUM
®
product line consists of a series of cigarette styles that vary
nicotine yields over a range – from very low (97% less nicotine than tobacco contained in conventional cigarette brands)
to relatively high nicotine yields. SPECTRUM
®
features 24 styles, in both regular and menthol versions, with 8 different
levels of nicotine. To date, agencies of the United States federal government have invested more than $125 million in independent
clinical studies using our SPECTRUM
®
research cigarettes. The results of these studies, as published in peer-reviewed
publications (including but not limited to the
New England Journal of Medicine
, the
Journal of the American Medical Association
,
and many others), show that our proprietary VLNC cigarettes containing our unique VLN
TM
tobacco are associated with:
(1) reduced smoking, (2) lower nicotine exposure, (3) increased quit attempts, and (4) lessened nicotine dependence, all with minimal
evidence of nicotine withdrawal symptoms, compensatory smoking, or serious adverse events. A list of completed and published clinical
studies using cigarettes made with 22nd Century’s VLN
TM
tobacco is shown on the Company’s website at
http://www.xxiicentury.com/published-clinical-studies/
.
A list of on-going clinical studies using
22nd Century’s SPECTRUM
®
research cigarettes is shown on the Company’s website at http://www.xxiicentury.com/on-going-clinical-studies/.
The numerous independent clinical studies on VLNC cigarettes provides the scientific foundation for the FDA’s announcement
on July 28, 2017 that the FDA plans to require that all combustible cigarettes sold in the United States contain only minimally
or non-addictive levels of nicotine. On March 19, 2018, the FDA publicly announced its Advance Notice of Proposed Rulemaking (“ANPRM”)
to solicit public comments on the FDA’s plan to enact a new nicotine reduction rule. On July 16, 2018, we publicly submitted
to the FDA our formal written response to the ANPRM in which we described how (i) the FDA’s proposed new rule is supported
by rigorous independent, published science, (ii) the FDA’s stated goal to render cigarettes minimally or non-addictive is
immediately feasible as evidenced by our production and delivery of more than 28 million VLNC research cigarettes since the year
2011, and (iii) the FDA’s proposed new rule is exceedingly practical and urgently needed in the interests of public health.
After we obtain all necessary regulatory approvals, we plan to offer our proprietary VLNC cigarettes for domestic sale, for international
sale, and for licensing by third parties.
In hemp/cannabis, we are developing proprietary
hemp strains for important new medicines and agricultural crops. Our current activities in the United States involve only work
with legal hemp in full compliance with U.S. federal and state laws. The hemp plant and the cannabis/marijuana plant are both
part of the same
cannabis sativa
genus/species of plant, except that hemp has not more than 0.3% dry weight content of
delta-9-tetrahydrocannabinol (“THC”). The 2018 federal Farm Bill legalized hemp and cannabinoids extracted from hemp
in the U.S., but such extracts remain subject to state laws and the regulation by other U.S. federal agencies, such as the FDA
and the U.S. Department of Agriculture (“USDA”). The same plant, with a higher THC content, is cannabis/marijuana,
which is legal under certain state laws, but which is currently not legal under U.S. federal law. We work only with legal hemp
in full compliance with federal and local laws. We have developed hemp plants with agronomically desirable traits for commercial
uses and/or unique cannabinoid levels for possible extraction purposes. We believe that we have many types of superior and unique
hemp plant varieties, including (i) hemp plants with low to no amounts of THC and other desirable agronomic traits for the legal
hemp industry and (ii) hemp plants with high levels of cannabidiol (“CBD”) and other non-THC cannabinoids for the
legal medical cannabinoid markets. In the United States, we are working with the University of Virginia (“UVA”) to
(i) create unique industrial hemp plants with guaranteed levels of THC below 0.3%, which is the legal limit that defines hemp
for optimal growth in Virginia, (ii) optimize other desirable hemp plant characteristics to improve the plant’s suitability
for growing in Virginia and in similar legacy tobacco regions of the United States, and (iii) utilize high-value medical cannabinoid
hemp varieties and specialized cannabinoid extraction processes for use in human therapeutics. We have also obtained a license
in the State of New York to research and grow hemp in that state. In Canada, we previously conducted sponsored research on the
hemp plant with Anandia Laboratories in Vancouver, British Columbia, in full compliance with Canadian regulations. In Europe,
we will be working with KeyGene NV, global leader in plant research involving high-value genetic traits and increased crop yields,
in an exclusive, worldwide collaboration that will focus on developing hemp/cannabis plants with exceptional cannabinoid profiles
and other superior agronomic traits for medical, therapeutic and agricultural uses, among many other applications.
Additional information about our business
and operations is contained in our Annual Report on Form 10-K for the year ended December 31, 2018. Information on our website
is not incorporated by reference into this Form 10-Q.
Strategic Objectives
Our strategic objectives include the following:
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Facilitating the implementation of the plan announced by the FDA to require that
all
combustible
cigarettes sold in the United States contain only minimally or non-addictive levels of nicotine;
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Continuing to work with the FDA on our Modified Risk Tobacco Product application that we have submitted
to the FDA to obtain a reduced exposure marketing authorization for our
BRAND A
Very Low Nicotine Content (“VLNC”)
cigarettes to be marketed in the United States under the proposed brand name of “VLN
TM”
as containing 95%
less nicotine than conventional tobacco cigarettes, and other related claims as may be approved by the FDA;
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Seeking licensing agreements for our VLNC tobacco technology and/or our VLNC proprietary tobaccos;
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Continuing to produce
SPECTRUM
®
research cigarettes for the National Institute on Drug Abuse (“NIDA”), which is part of the National Institutes of Health (“NIH”), for use in independent clinical studies;
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Continuing to research and develop other novel tobacco plant varieties;
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Continuing to explore opportunities outside of the United States for the use of our VLNC tobacco in potential over-the-counter cigarettes, such as
BRAND A
, or in a potential prescription-based, smoking cessation aid, such as
X-22
, in foreign countries that may desire such products;
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Continuing to expand our legal hemp/cannabis activities and development of unique plant varieties of hemp,
including (i) hemp plants with other desirable agronomic traits in addition to low to no amounts of THC for the legal hemp industry,
and (ii) hemp plants with high levels of cannabidiol (“CBD”) and other non-THC cannabinoids for the legal medical cannabinoid
markets;
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Continuing to explore opportunities outside of the United States for the sale of our branded proprietary tobacco products; and
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Continuing to grow our contract manufacturing business for third-party branded tobacco products.
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For the first quarter of 2019, our accomplishments and notable
events include:
On March 27, 2019, we announced the results
of a recently completed, Company-sponsored study involving our Very Low Nicotine Content (“VLNC”) cigarettes, with
the results of such study indicating that subjects using our VLNC product had 97% less nicotine in their blood as compared to their
blood-nicotine levels after use of their usual brand of highly addictive commercial cigarettes. In contrast, when the study subjects
used nicotine gum, which is a common nicotine replacement therapy, the users’ nicotine level in their blood was only 69%
less than when they used their usual brand of cigarettes. The study results also showed that the users’ cravings for cigarettes
and urge to smoke were significantly reduced when using our VLNC product. Overall, the results of this study suggest that (i) VLNC
cigarettes have a lower potential for abuse than conventional cigarettes, and (ii) VLNC cigarettes have a potential for abuse that
may be comparable to using nicotine gum. We included this study and its results in our Modified Risk Tobacco Product (“MRTP”)
application submitted to the U.S. Food and Drug Administration (“FDA”) for our VLNC cigarettes under the proposed brand
name VLN™. Our MRTP application seeks the FDA’s authorization to advertise that VLN™ cigarettes contain 95% less
nicotine as compared to the 100 top-selling cigarette brands in the United States.
Subsequent to the close of the first quarter of 2019,
we also announced:
On April 9, 2019, we announced that we
had entered into a worldwide strategic research and development agreement with KeyGene NV, a global leader in plant research involving
high-value genetic traits and increased crop yields. This exclusive, worldwide collaboration will focus on the development of
hemp/cannabis plants with exceptional cannabinoid profiles for medical and therapeutic use, among other applications and other
improved agronomic traits for commercial crop applications for agricultural uses. The KeyGene collaboration provides us with access
to a unique suite of crop innovation platforms, including genomics, molecular genetics, trait discovery and breeding technologies.
Under the agreement, we will hold exclusive worldwide rights to all hemp/cannabis plant lines, intellectual property on metabolic
traits, and research results that are developed through the partnership. We announced that the focus of the collaboration will
specifically include the following:
(i) Creating a genetic database which utilizes the
results of genomic analyses of several hundred existing, exceptional hemp/cannabis plant lines for use in the acceleration of our
development and licensing of uniquely characterized and improved hemp/cannabis plants;
(ii) Enhancing genetic variation to empower our development
of new and significantly improved varieties of hemp/cannabis plant lines and varieties with highly desirable cannabinoid profiles
optimized for medicinal or therapeutic applications;
(iii) Creating a proprietary and industry-leading
high-resolution “molecular genetic map” of the entire cannabis plant genome to facilitate rapid, cost-effective breeding
of innovative varieties of hemp/cannabis plants with distinctive agronomic traits;
(iv) Analyzing the genomic sequences of multiple species
of the hemp/cannabis plant and identifying shared genetic markers, allowing us to develop improved commercial hemp/cannabis plant
lines more rapidly than through conventional plant breeding approaches; and
(v) Initiating the rapid-cycle generation of hemp/cannabis
plant lines with distinctive cannabinoid and terpene profiles to create elite lines.
On April 17, 2019, we announced the hiring
of John Pritchard as our new Vice President of Regulatory Science. Mr. Pritchard was formerly the Head of Regulatory Science for
Imperial Brands, U.K., one of the largest tobacco companies in the world. Over the course of his 12 years with Imperial Brands,
Mr. Pritchard served in key management roles in product stewardship, compliance, research, and regulatory departments. As the head
of Imperial Brand’s scientific regulatory engagement team, Mr. Pritchard led Imperial Brand’s technical regulatory
strategy and external scientific engagement on global product regulation. Mr. Pritchard has also held other scientific and regulatory
posts in the private and public sector, including roles with Charles River, a leading global contract research organization, and
with the U.K. Health Protection Agency (now, Public Health England). Mr. Pritchard received a Master of Science Degree in Toxicology
from the University of Birmingham, England and his Bachelor of Science Degree in Pharmacology from the University of Aberdeen,
Scotland. With work cited by the U.S. Surgeon General, the World Health Organization, and Public Health England, Mr. Pritchard
has considerable experience in the fields of tobacco harm reduction and next generation tobacco products. Mr. Pritchard will lead
and oversee our global regulatory and compliance activities and he will engage with the FDA in support of our MRTP application
for VLN™ cigarettes. In addition, Mr. Pritchard will work in support of the planned rule by the FDA to require the reduction
of the nicotine content of all cigarettes sold in the U.S. to “minimally or non-addictive levels.” Mr. Pritchard will
also lead our initiatives with foreign governments that are interested in 22nd Century’s proprietary VLNC tobacco for use
in their countries.
On April 30, 2019, we announced that the
FDA conducted a comprehensive inspection of our manufacturing facility in North Carolina as a part of the FDA’s review of
our Pre-Market Tobacco (PMT) application for our VLNC cigarettes under the proposed brand name VLN™, in which application
we seek the FDA’s authorization to commercialize VLN™ brand cigarettes and to communicate to consumers that VLN™
cigarettes contain at least 95% less nicotine as compared to the 100 leading cigarette brands in the United States. The FDA’s
inspection was part of the third phase of the FDA’s four phase review process for the PMT application. The FDA’s
stated goal for the inspection was “to verify the information and data contained in the [PMT] application.” As
such, the FDA inspectors witnessed production of our proprietary VLN™ cigarettes and the FDA inspectors reviewed our raw
material receiving and storage procedures, quality control processes, manufacturing equipment and systems, tobacco processing methods,
and finished-products analyses procedures.
Three Months Ended March 31, 2019 Compared to Three Months
Ended March 31, 2018
Revenue - Sale of products, net
In the three months ended March 31, 2019, we realized net sales revenue from the sale of products in the amount
of $6,293,648, an increase of $177,609, or 2.9%, from net sales revenue of $6,116,039 for the three months ended March 31, 2018.
The increase in net sales revenue for the first quarter of 2019 was primarily the result of an increase in the sale of contract
manufactured filtered cigars of approximately $294,000, and a net increase in other miscellaneous sales activities of approximately
$16,000, partially offset by a decrease in the sales of contract manufactured cigarettes of $132,000, as compared to the first
quarter of 2018.
Cost of goods sold - Products / Gross profit (loss)
During the three months ended March 31,
2019, cost of goods sold were $6,396,558, or 101.6%, of net sales revenue, resulting in a gross loss on sales of products in the
amount of $102,910. During the three months ended March 31, 2018, cost of goods sold were $6,044,461, or 98.8%, of net sales revenue,
resulting in a gross profit on sales of products in the amount of $71,578. The negative change from a gross profit for the three
months ended March 31, 2018 to a gross loss for the three months ended March 31, 2019 was primarily the result of additional expenses
recorded to the cost of goods sold during the first quarter of 2019, as compared to the first quarter of 2018. The additional
expenses consisted primarily of (1) an increase in fees due to the FDA on filtered cigars of approximately $100,000, and (2) a
net increase in other manufacturing expenses charged to the cost of goods sold of approximately $60,000, relating mainly to labor
and equipment maintenance costs.
Research and development expense
Research and development (“R&D”)
expense was $2,451,442 in the three months ended March 31, 2019, a decrease of $65,327, or 2.6%, from $2,516,769 in the three months
ended March 31, 2018. This decrease was primarily the result of a decrease in equity-based compensation expense of approximately
$121,000, a decrease in payroll and related benefits of approximately $95,000, a decrease in product testing costs of approximately
$48,000, a decrease in costs relating to our MRTP application with the FDA for our VLNC cigarettes of approximately $36,000, and
a net decrease in various other R&D expenses of approximately $3,000, partially offset by an increase in sponsored research
costs of approximately $154,000, an increase in costs related to our laboratory operations of approximately $63,000, and an increase
in consulting fees of approximately $21,000.
General and administrative expense
General and administrative expense was $2,242,502
in the three months ended March 31, 2019, an increase of $210,110, or 10.3%, from $2,032,392 in the three months ended March 31,
2018. The increase was mainly due to an increase in payroll and related benefits of approximately $23,000, an increase in legal
and accounting fees of approximately $135,000, an increase in business insurance costs of approximately $21,000, an increase in
Board of Director related expenses of approximately $36,000, an increase in consulting and other professional services of approximately
$75,000, an increase in travel related expenses of approximately $33,000, and a net increase in various other general and administrative
expenses of approximately $57,000, partially offset by a decrease in expenses relating to investor relations of approximately $170,000.
Sales and marketing
During the three months ended March 31, 2019, we incurred sales and marketing expenses of $231,699, an
increase of $32,590, or 16.4%, from $199,109 in the three months ended March 31, 2018. The increase in sales and marketing expenses
was primarily the result of an increase in payroll and related benefit costs of approximately $20,000, an increase in equity-based
compensation of approximately $14,000, and an increase in travel related expenses of approximately $9,000, partially offset by
a decrease in expenses relating to advertising of approximately $10,000.
Depreciation expense
Depreciation expense for the three months
ended March 31, 2019 amounted to $135,047, an increase of $10,519, or 8.5%, from $124,528 for the three months ended March 31, 2018.
The increase was primarily due to depreciable acquisitions of machinery and equipment during the year ended December 31, 2018 and
the three months ended March 31, 2019 in the aggregate amount of approximately $753,000, primarily consisting of equipment additions
in our NASCO factory operations in North Carolina.
Amortization expense
Amortization expense for the three months
ended March 31, 2019 amounted to $215,559, an increase of $48,007, or 28.7%, from $167,552 for the three months ended March 31,
2018. The amortization expense relates to amortization taken on capitalized patent costs and license fees. The increase was primarily
due to amortization taken on additional patent costs incurred during the three months ended March 31, 2019 and the year ended December
31, 2018 of approximately $187,000 and $751,000, respectively, and additional amortization of approximately $35,000 taken during
the first quarter of 2019 on the cost of a new licenses with NCSU and the University of Kentucky that began in the third and fourth
quarters of 2018.
Unrealized gain on investment
The warrants to purchase 973,971
shares of Aurora common stock, described in Note 4 to our consolidated financial statements, are considered an equity
security, and are recorded at fair value. We recorded the fair value of the stock warrants of $6,065,891 at March 31, 2019,
using the Black-Scholes pricing model, and recorded an unrealized gain on the warrants in the amount of $2,973,533 for the
three months ended March 31, 2019.
During the first quarter of 2018, we began
accounting for our equity investment in Anandia in accordance with 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, we are required to measure our investment in Anandia at fair value at the end
of each reporting period and recognize changes in fair value in net income. A practicability exception is available for equity
investments that do not have readily determinable fair values, however; the exception requires us to adjust the carrying amount
for impairment and 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 by Anandia during January of 2018 (an orderly transaction), we recorded an unrealized
gain on our investment in Anandia in the amount of $6,147,088 for the three months ended March 31, 2018.
Realized (loss) gain on short-term investment securities
We maintain a short-term investment account
to invest our excess cash. Investments in the short-term investment account are managed in accordance with our investment policy.
We realized a (loss) gain on short-term investment securities of ($16,021) and $195 for the three months ended March 31, 2019 and
2018, respectively, resulting from the maturity of various debt instruments held in the short-term investment account.
Unrealized loss on short-term investment securities
During the three months ended March 31, 2018, the unrealized loss on short-term investment securities
of $92,574 was recorded in the Other income (expense) section of our Consolidated Statements of Operations and Comprehensive Income
(Loss) and was reclassified to Other comprehensive income (loss) in the second quarter of 2018.
Gain on the sale of machinery and equipment
During the three months ended March 31,
2019, we sold a piece of machinery and equipment no longer required in our factory operations in North Carolina and recorded a
gain on the sale in the amount of $87,351.
Warrant liability gain, net
During July of 2018, the remaining stock
warrants containing the anti-dilutive features that created the warrant liability were exercised on a cashless basis. Accordingly,
there was no warrant liability gain (loss) for the first quarter of 2019 and there will be no warrant liability gain (loss) in
future periods unless we issue securities containing anti-dilution features.
The warrant liability gain of $48,711 for
the first quarter of 2018 was due to a decrease in the estimated fair value of the warrants during the period.
Interest income, net
Interest income, net for the three months
ended March 31, 2019, was $272,243, an increase of $20,403, or 8.1%, from interest income of $251,840 for the three months ended
March 31, 2018. The increase in net interest income (interest income less investment fees) was the result of additional net interest
earned in our short-term investment account primarily due to higher interest rates on outstanding investments during the three
months ended March 31, 2019, as compared to interest rates on outstanding investments during the three months ended March 31, 2018.
Interest expense
Interest expense was $10,660 for the three months ended March 31, 2019 and was derived from the accretion
of interest on notes payable to NCSU and the University of Kentucky. We had no interest expense for the three months ended March
31, 2018.
Net (loss) income
We had a net loss for the three months ended March 31, 2019 of $2,072,713 as compared to net income of $1,386,488
in the three months ended March 31, 2018. The change from net income for the three months ended March 31, 2018 to a net loss for
the three months ended March 31, 2019 amounted to a decrease of $3,459,201, or 249.5%, and was primarily the result of a decrease
in the unrealized gain on investment of approximately $3,174,000, a negative change in the gross profit (loss) on product sales
of approximately $174,000, and an increase in operating expenses of approximately $236,000, partially offset by a net increase
in various other income (expenses) of approximately $125,000.
Other comprehensive income – unrealized gain on
short-term investment securities, net
We maintain an account for short-term investment securities that are classified as available-for-sale securities
and consist of money market funds, corporate bonds, U.S. government agency bonds, and U.S. treasury securities with maturities
greater than three months at the time of acquisition. Unrealized gains and losses on short-term investment securities (the adjustment
to fair value) are recorded as Other comprehensive income or loss. We recorded an unrealized gain on short-term investment securities
in the amount of $146,899 and recorded a reclassification of losses to net loss in the amount of $16,021, resulting in other comprehensive
income in the amount of $162,920 for the three months ended March 31, 2019.
Liquidity and Capital Resources
Working Capital
As of March 31, 2019, we had working capital of approximately $51.3 million compared to working capital
of approximately $56.0 million at December 31, 2018, a decrease of approximately $4.7 million. This decrease in working capital
was primarily due to a decrease in net current assets of approximately $3.7 million and an increase in net current liabilities
of approximately $1.0 million. Cash, cash equivalents and short-term investment securities decreased by approximately $4.5 million
and the remaining net current assets increased by approximately $0.8 million. We used approximately $4.7 million of cash in operating
activities during the three months ended March 31, 2019.
We must successfully execute our business
plan to increase revenue in order to achieve positive cash flows from operations to sustain adequate liquidity without requiring
additional funds from capital raises and other external sources to meet minimum operating requirements. On December 30, 2016, we
filed a Form S-3, universal shelf registration statement with the U.S. Securities and Exchange Commission (“SEC”) that
was declared effective by the SEC on January 17, 2017. The universal shelf registration statement will allow, but not compel, the
Company to raise up to $100 million of capital over a three-year period ending January 17, 2020 through a wide array of securities
at times and in amounts to be determined by the Company. Following the October 2017 registered direct offering, the universal shelf
registration has approximately $46 million of remaining capacity. If required, there can be no assurance that additional capital
will be available on acceptable terms or at all.
Cash demands on operations
We had cash and cash equivalents and short-term investment securities at March 31, 2019 of $51,852,855.
We believe this amount of cash and cash equivalents and short-term investment securities will be adequate to sustain normal operations
and meet all current obligations as they come due for a number of years. During the three months ended March 31, 2019, we experienced
an operating loss of approximately $5,379,000 (including approximately $1,211,000 in expenses relating to our MRTP application)
and used cash in operations of approximately $4,682,000. Excluding discretionary expenses relating to R&D, patent and trademark
costs, contract growing of our proprietary tobacco, modified risk tobacco products and certain nonrecurring expenses relating to
factory capital expenses, investor relations and marketing costs, our monthly cash expenditures are approximately $950,000. In
addition, we expect to incur an estimated amount of approximately an additional $400,000 in expenses relating to our MRTP application
over approximately the next three months.
Net cash used in operating activities
In the three months ended March 31, 2019, $4,681,789 of cash was used in operating activities as compared
to $3,143,878 of cash used in operating activities in the three months ended March 31, 2018, an increase of $1,537,911. The increase
in use of cash in operations was primarily due to an increase in the cash portion of the net loss in the amount of $391,750 and
an increase in cash used for working capital components related to operations in the amount of $1,146,161 for the three months
ended March 31, 2019 as compared to the three months ended March 31, 2018.
Net cash provided by investing activities
In the three months ended March 31, 2019,
net cash provided by investing activities was $4,665,825, as compared to $4,812,088 of cash provided by investing activities during
the three months ended March 31, 2018, a decrease in net cash provided by investing activities of $146,263. The decrease was primarily
the result of a decrease in net cash provided from transactions relating to our short-term investment account in the amount of
$386,281, partially offset by a net decrease in cash used for the acquisition of patents and trademarks and in the acquisition
of machinery and equipment in the aggregate amount of $73,868, and an increase in cash provided by the sale of machinery and equipment
in the amount of $166,150.
Net cash provided by financing activities
During the three months ended March 31,
2019, there was no cash provided by or used in financing activities. During the three months ended March 31, 2018, we had $217,500
of cash provided by financing activities from the exercise of various stock options.
Critical Accounting Policies and Estimates
There have been no material changes to the information set forth in our Annual Report on Form 10-K for the
year ended December 31, 2018, except for the adoption of ASU 2016-02, Leases, on January 1, 2019 as more fully described in Note
3 to our Consolidated Financial Statements.
Inflation
Inflation did not have a material effect
on our operating results for the three months ended March 31, 2019 and 2018, respectively.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements
as defined by Item 303(a)(4) of Regulation S-K.