NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2018
(unaudited)
NOTE 1. - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
Basis of Presentation
-
The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting
principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q. Accordingly, they do
not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management,
all adjustments consisting of normal recurring accruals considered necessary for a fair and non-misleading presentation of the
financial statements have been included.
Operating results for the six months ended
June 30, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018. The balance
sheet as of December 31, 2017 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, 2017 audited consolidated financial statements and the notes thereto contained
in our Annual Report on Form 10-K for the year ended December 31, 2017, as filed with the Securities and Exchange Commission on
March 7, 2018.
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. The Company acquired the membership interests of NASCO on August 29, 2014. 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
an investment in Anandia Laboratories, Inc. more fully described in Note 6.
Reclassifications
–
Certain items in the 2017 financial statements have been reclassified to conform to the 2018 classification.
Preferred stock authorized
-
The Company is authorized to issue “blank check” preferred stock, which could be issued with voting, liquidation,
dividend and other rights superior to our common stock.
Concentration of Credit Risk
-
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. Cash equivalents included in this category consist of a bank certificate of deposit. 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, with fair value based on either quoted market prices or pricing
models maximizing the use of observable inputs for similar securities. The Company views its available-for-sale securities as available
for use in current operations regardless of the stated maturity date of the security. The Company’s investment policy states
that all investment securities must have a maximum maturity of twenty-four (24) months or less and the maximum weighted maturity
of the investment securities must not exceed twelve (12) months. Unrealized gains and losses on short-term investment securities
(the adjustment to fair value) are recorded as other comprehensive income or loss on the Company’s Consolidated Statements
of Operations and Comprehensive Loss. Realized gains and losses on short-term investment securities are recorded in the other income
(expense) portion of the Company’s Consolidated Statements of Operations and Comprehensive Loss. Interest earned, net of
investment fees, on the short-term investment securities are included in interest income.
Accounts receivable
- The
Company periodically reviews aged account balances for collectability. The Company established an allowance for doubtful accounts
of $0 at both June 30, 2018 and December 31, 2017.
Inventory
-
Inventories
are valued at the lower of cost or net realizable value. Cost is determined using an average cost method for tobacco leaf inventory
and raw materials inventory and standard cost is primarily used for finished goods inventory. Inventories are evaluated to
determine whether any amounts are not recoverable based on slow moving or obsolete condition and are written off or reserved as
appropriate. Inventories at June 30, 2018 and December 31, 2017 consisted of the following:
|
|
June 30,
|
|
|
December 31,
|
|
|
|
2018
|
|
|
2017
|
|
Inventory - tobacco leaf
|
|
$
|
1,582,976
|
|
|
$
|
1,552,474
|
|
Inventory - finished goods
|
|
|
|
|
|
|
|
|
Cigarettes and filtered cigars
|
|
|
205,617
|
|
|
|
289,004
|
|
Inventory - raw materials
|
|
|
|
|
|
|
|
|
Cigarette and filtered cigar components
|
|
|
1,314,374
|
|
|
|
1,636,059
|
|
|
|
|
3,102,967
|
|
|
|
3,477,537
|
|
Less: inventory reserve
|
|
|
160,000
|
|
|
|
195,000
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
2,942,967
|
|
|
$
|
3,282,537
|
|
Machinery and equipment
-
Machinery and equipment are recorded at their acquisition cost and depreciated on a straight-line basis over their estimated
useful lives ranging from 3 to 10 years. Depreciation commences when the asset is placed in service.
Intangible Assets
-
Intangible
assets are recorded at cost and consist primarily of (1) expenditures incurred with third-parties related to the processing of
patent claims and trademarks with government authorities, as well as costs to acquire patent rights from third-parties, (2) license
fees paid for third-party intellectual property, (3) costs to become a signatory under the tobacco MSA, and (4) license fees paid
to acquire a predicate cigarette brand. The amounts capitalized relate to intellectual property that the Company owns or to which
it has exclusive rights. The Company’s intellectual property capitalized costs are amortized using the straight-line method
over the remaining statutory life of the granted patent assets in each of the Company’s patent families, which have estimated
expiration dates ranging from 2018 to 2034. Periodic maintenance or renewal fees are expensed as incurred. Annual minimum license
fees are charged to expense. License fees paid for third-party intellectual property are amortized on a straight-line basis over
the last to expire patents, which patent expiration dates range from 2019 through 2034. The Company believes costs associated with
becoming a signatory to the MSA and acquiring a predicate cigarette brand have an indefinite life and as such, no amortization
is taken. Total intangible assets at June 30, 2018 and December 31, 2017 consisted of the following:
|
|
June 30,
|
|
|
December 31,
|
|
|
|
2018
|
|
|
2017
|
|
Intangible assets, net
|
|
|
|
|
|
|
|
|
Patent and trademark costs
|
|
$
|
6,695,610
|
|
|
$
|
6,327,467
|
|
Less: accumulated amortization
|
|
|
2,806,932
|
|
|
|
2,517,465
|
|
Patent and trademark costs, net
|
|
|
3,888,678
|
|
|
|
3,810,002
|
|
|
|
|
|
|
|
|
|
|
License fees, net (see Note 10)
|
|
|
2,625,226
|
|
|
|
1,450,000
|
|
Less: accumulated amortization
|
|
|
375,602
|
|
|
|
326,591
|
|
License fees, net
|
|
|
2,249,624
|
|
|
|
1,123,409
|
|
|
|
|
|
|
|
|
|
|
MSA signatory costs
|
|
|
2,202,000
|
|
|
|
2,202,000
|
|
|
|
|
|
|
|
|
|
|
License fee for predicate cigarette brand
|
|
|
300,000
|
|
|
|
300,000
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
8,640,302
|
|
|
$
|
7,435,411
|
|
Amortization expense relating to the above
intangible assets for the three and six months ended June 30, 2018 and 2017 amounted to $170,925 and $338,477, respectively ($143,010
and $283,898 for the three and six months ended June 30, 2017, respectively).
The estimated annual average amortization
expense for the next five years is approximately $355,000 for patent costs and $98,000 for license fees.
Impairment of Long-Lived Assets
-
The Company reviews the carrying value of its amortizing long-lived assets whenever events or changes in circumstances indicate
that the historical cost-carrying value of an asset may no longer be recoverable. The Company assesses recoverability of the asset
by estimating the future undiscounted net cash flows expected to result from the asset, including eventual disposition. If the
estimated future undiscounted net cash flows are less than the carrying value of the asset, an impairment loss is recorded equal
to the difference between the asset’s carrying value and its fair value. There was no impairment loss recorded during the
six months ended June 30, 2018 or 2017, 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 loss and credit carry-forwards.
Considering the Company’s history
of cumulative net operating losses and the uncertainty of their future utilization, the Company has established a valuation allowance
to fully offset its net deferred tax assets as of June 30, 2018 and December 31, 2017.
The Company’s federal and state tax
returns for the years ended December 31, 2014 through December 31, 2016 are currently open to audit under the statutes of limitations.
There were no pending audits as of June 30, 2018.
The Tax Cuts and Jobs Act of 2017 (the “TCJA”)
was signed into law on December 22, 2017. The TCJA includes significant changes to the U.S. corporate income tax system, including
a Federal corporate rate reduction from 35% to 21%. In accordance with a question and answer document issued by the Financial Accounting
Standards Board (“FASB”) staff on January 18, 2018, the Company is applying the guidance in Securities and Exchange
Commission Staff Accounting Bulletin (“SAB”) 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act,
which provides guidance on applying FASB Accounting Standards Codification (“ASC”) 740, Income Taxes, if the accounting
for certain income tax effects of the TCJA are incomplete by the time the financial statements are issued for a reporting period.
Specifically, SAB 118 permits companies to use reasonable estimates and provisional amounts for some line items for taxes when
preparing year-end 2017 financial statements. The Company completed the accounting under the TCJA, and accordingly, has reported
the effects in the Company’s consolidated financial statements for the year ended December 31, 2017.
Stock Based Compensation
-
The Company uses a fair-value based method to determine compensation for all arrangements under which Company employees and
others receive shares or options to purchase common shares of the Company. Stock based compensation expense is recorded over the
requisite service period based on estimates of probability and time of achieving milestones and vesting. For accounting purposes,
the shares will be considered issued and outstanding upon vesting.
Revenue Recognition
-
On January
1, 2018, the Company adopted ASC 606, Revenue from Contracts with Customers and all related amendments (the “new revenue
standard”) for all contracts using the modified retrospective method. Under the modified retrospective method, the Company
was required to record a cumulative-effect adjustment to the opening balance of retained earnings on January 1, 2018. The Company
has determined that the adoption of the new revenue standard did not require a cumulative-effect adjustment. The comparative information
has not been restated and continues to be reported under the accounting standards in effect for those periods.
The Company recognizes revenue when it satisfies
a performance obligation by transferring control of the product to a customer. The Company’s customer contracts consist of
obligations to manufacture the customer’s branded filtered cigars and cigarettes. For certain contracts, the performance
obligation is satisfied over time as the Company determines, due to contract restrictions, it does not have an alternative use
of the product, and it has an enforceable right to payment as the product is manufactured. The Company recognizes revenue under
those contracts at the unit price stated in the contract based on the units manufactured. The manufacturing process is completed
on a daily basis and, therefore, there were no performance obligations partially satisfied at June 30, 2018. 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 June 30, 2018 and December 31, 2017.
The Company generally requires a down payment
from its customers prior to commencement of manufacturing the product. Amounts received in advance of satisfying the performance
obligations are recorded as deferred revenue. Customer payment terms vary depending on the terms of each customer contract, but
payment is generally due prior to product shipment or within extended credit terms up to twenty-one (21) days after shipment.
The Company’s net sales revenue is
derived from customers located primarily in the United States of America and is disaggregated by the timing of revenue recognition.
For the three and six months ended June 30, 2018, net sales revenue from products transferred over time amounted to approximately
$4,569,000 and $8,492,000, respectively, and net sales revenue from products transferred at a point in time amounted to approximately
$2,346,000 and $4,539,000, respectively.
Derivatives
-
The Company
does not use derivative instruments to hedge exposures to cash flow, market or foreign currency risks. The Company evaluates all
our financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives.
For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at
its fair market value and then is revalued at each reporting date, with changes in fair value reported in the Consolidated Statements
of Operations and Comprehensive Loss. The methodology for valuing our outstanding warrants classified as derivative instruments
utilizes a lattice model, which includes probability weighted estimates of future events, including volatility of our common stock.
The classification of derivative instruments, including whether such instruments should be recorded as liabilities or equity, is
evaluated at the end of each reporting period. Derivative instrument liabilities are classified on the balance sheet as current
or non-current based on if the net-cash settlement of the derivative instrument could be required within twelve months of the balance
sheet date.
Research and Development
-
Research and development costs are expensed as incurred.
Advertising
- The Company
expenses advertising costs as incurred. Advertising expense was approximately $4,000 and $16,000 for the three and six months ended
June 30, 2018, respectively ($12,000 and $43,000 for the three and six months ended June 30, 2017, respectively).
Loss Per Common Share
-
Basic loss per common share is computed using the weighted-average number of common shares outstanding. Diluted loss per share
is computed assuming conversion of all potentially dilutive securities. Potential common shares outstanding are excluded from the
computation if their effect is anti-dilutive.
Commitment and Contingency Accounting
-
The Company evaluates each commitment and/or contingency in accordance with accounting standards, which state that if the
item is more likely than not to become a direct liability, then the Company will record the liability in the financial statements.
If not, the Company will disclose any material commitments or contingencies that may arise.
Use of Estimates
-
The preparation
of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Actual results
could differ from those estimates.
Fair Value of Financial Instruments
-
The Company’s financial instruments include cash and cash equivalents, short-term investment securities,
accounts receivable, accounts payable, accrued expenses and warrant liability. Other than for cash equivalents, short-term investment
securities and warrant liability, fair value is assumed to approximate carrying values for these financial instruments, since they
are short term in nature, they are receivable or payable on demand, or had stated interest rates that approximate the interest
rates available to the Company as of the reporting date. The determination of the fair value of cash equivalents, short-term investment
securities and warrant liability are discussed in Note 7.
Investments -
The Company
accounts for investments in equity securities of other entities under the equity method of accounting if the Company’s investment
in the voting stock of the other entity is greater than or equal to 20% and less than a majority, and the Company has the ability
to have significant influence over the operating and financial policies of the investee. If the Company’s equity investment
in other entities is less than 20%, and the Company has no significant influence over the operating or financial policies of the
entity, and such equity investment does not have a readily determinable market value, then the Company accounts for such equity
investments in accordance with FASB ASU 2016-01, which the Company adopted in the first quarter of 2018 with respect to the Company’s
investment in Anandia Laboratories, Inc. in Canada (see Note 6 for a further discussion). The Company used the cost method of accounting
with respect to its investment in Anandia Laboratories for prior periods.
Accounting Pronouncements -
In
February 2016, the FASB issued ASU 2016-02, “Leases,” which supersedes existing lease guidance under GAAP. Under the
new guidance, lessees will be required to recognize leases as right of use assets and liabilities for leases with lease terms of
more than twelve months. The guidance will apply for both finance and operating leases. The effective date for the ASU is for annual
periods beginning after December 15, 2018 and interim periods therein. The Company is currently evaluating the impact of the ASU
on its consolidated financial statements.
NOTE 2. – OCTOBER 2017 REGISTERED DIRECT OFFERING
On October 10, 2017, the Company closed
a registered direct offering (the “Offering”) with institutional investors purchasing an aggregate of 20,570,000 shares
of the Company’s common stock at a price of $2.6250 per share generating net cash proceeds for the Company of $50,732,200,
after deducting expenses associated with the transaction. The securities purchase agreement entered into with the institutional
investors provides that, subject to certain exceptions, for a period of one year following the closing of the Offering, the Company
will be prohibited from effecting or entering into an agreement to effect any issuance by the Company or any of its subsidiaries
of common stock or common stock equivalents (or a combination of units thereof) involving a variable rate transaction, which generally
includes any transaction in which the Company (i) issues or sells any debt or equity securities that are convertible into, exchangeable
or exercisable for, or include the right to receive additional shares of common stock either (A) at a conversion price or exchange
rate that is based upon and/or varies with the trading prices of or quotations for the shares of common stock at any time after
the initial issuance of such securities, or (B) with a conversion, exercise or exchange price that is subject to being reset at
some future date after the initial issuance of such debt or equity security or upon the occurrence of specified or contingent events
directly or indirectly related to the business of the Company or the market for the common stock or (ii) enters into any agreement,
whereby the Company may issue securities at a future determined price.
NOTE 3. – JUNE 2017 WARRANT EXERCISE AGREEMENTS
On June 19, 2017, the Company entered into
Warrant Exercise Agreements (the “Agreements”) with all of the holders (the “Holders”) of outstanding warrants
to purchase up to 7,043,211 shares of common stock of the Company at $1.00 per share and warrants to purchase up to 4,250,000 shares
of common stock of the Company at $1.45 per share (collectively, the “Warrants”). These Warrants to purchase shares
of the Company’s common stock were acquired by the Holders in registered direct offerings in October of 2016 and in July
of 2016, respectively. The Company and the Holders agreed that the Holders would, subject to beneficial ownership limitations on
exercise contained in the Warrants, exercise all the Warrants for cash. In June 2017, the Holders exercised 3,229,711 Warrants
at $1.00 per share and 2,354,948 Warrants at $1.45 per share, resulting in net proceeds to the Company in the amount of $6,169,212,
after deducting expenses associated with the transaction. In July and August of 2017, the Holders exercised 3,813,500 Warrants
at $1.00 per share and 1,895,052 Warrants at $1.45 per share, resulting in net proceeds to the Company in the amount of $6,167,646,
after deducting expenses associated with the transaction.
In consideration for the Holders exercising
their Warrants for cash, the Company issued to each Holder a new warrant (the “New Warrants”) to purchase shares of
common stock of the Company equal to the number of shares of common stock received by each Holder upon the cash exercise of the
Holder’s Warrants. The terms of the New Warrants are substantially similar to the terms of the Warrants exercised, except
the New Warrants (i) have an exercise price equal to $2.15 per share and (ii) are exercisable six months from the date of issuance
of the New Warrants for a period of five (5) years. Accordingly, the Company issued an aggregate of 11,293,211 New Warrants to
the Holders, upon exercise of the Holder’s Warrants as described above. The New Warrants had a fair value of $16,049,031
at issuance and have been recorded as an adjustment to capital in excess of par value.
NOTE 4. - MANUFACTURING FACILITY
The Company’s manufacturing operations
at its North Carolina factory began approaching production capacity during the six months ended June 30, 2018. The Company significantly
expanded capacity during the second and third quarters of 2017 in order to fulfill anticipated new manufacturing contracts. In
mid-May of 2017, the Company began the first phase of a manufacturing contract for an existing brand of filtered cigars under a
new contract manufacturing agreement (the “New Agreement”) with a third-party and continued manufacturing a third-party
MSA cigarette brand and other filtered cigars on a contract basis. The production volume under the New Agreement continued to increase
during the first and second quarters of 2018, has resulted in an increase in the utilization of production capacity, required the
hiring of additional personnel, and investment in additional manufacturing equipment for the factory. Raw material component costs,
direct manufacturing costs, and an overhead allocation are included in the Cost of goods sold and Finished goods inventory. General
and administrative expenses of the factory amounted to $318,511 and $629,439 for the three and six months ended June 30, 2018,
respectively ($215,941 and $334,691 for the three and six months ended June 30, 2017, respectively).
NOTE 5. - MACHINERY AND EQUIPMENT
Machinery and equipment at June 30, 2018
and December 31, 2017 consisted of the following:
|
|
Useful Life
|
|
June 30,
2018
|
|
|
December 31,
2017
|
|
Cigarette manufacturing equipment
|
|
3 - 10 years
|
|
$
|
4,522,479
|
|
|
$
|
4,302,299
|
|
Office furniture, fixtures and equipment
|
|
5 years
|
|
|
135,909
|
|
|
|
110,499
|
|
Laboratory equipment
|
|
5 years
|
|
|
86,609
|
|
|
|
32,193
|
|
Leasehold improvements
|
|
6 years
|
|
|
163,359
|
|
|
|
106,429
|
|
|
|
|
|
|
4,908,356
|
|
|
|
4,551,420
|
|
Less: accumulated depreciation
|
|
|
|
|
1,491,194
|
|
|
|
1,235,373
|
|
Machinery and equipment, net
|
|
|
|
$
|
3,417,162
|
|
|
$
|
3,316,047
|
|
Depreciation expense was $131,294 and $255,822
for the three and six months ended June 30, 2018, respectively ($88,464 and $176,585 for the three and six months ended June 30,
2017, respectively).
NOTE 6. - INVESTMENT
The Company (through its wholly-owned subsidiary,
Botanical Genetics), holds a 14.8% equity investment in Anandia Laboratories, Inc., a Canadian plant biotechnology company (“Anandia”).
At June 30, 2018 and December 31, 2017, the Company’s investment balance in Anandia was $7,513,581 and $1,366,493, respectively,
and is classified within Other assets on the accompanying Consolidated Balance Sheets. During the first quarter of 2018, the Company
began accounting for its 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, 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. A practical expedient is available for equity
investments that do not have readily determinable fair values, however; the exception requires the Company 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 December of 2017 and January of 2018 (orderly transactions),
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 was no change in the fair value of the Company’s equity investment in Anandia during the three months
ended June 30, 2018.
During the first quarter of 2017, a dilutive
event occurred bringing the Company’s investment percentage in Anandia below 20%, a threshold for the use of the equity method
of accounting that the Company had previously used to account for its investment in Anandia. Accordingly, the Company discontinued
applying the equity method of accounting for its investment in Anandia. After the dilutive event, the Company accounted for its
investment in Anandia under the cost method of accounting until it adopted ASU 2016-01, as described above. The Company’s
gain on the investment in Anandia was $346,180 for the three months ended March 31, 2017.
On July 15, 2018, Anandia signed a binding
Arrangement Agreement to be acquired by Aurora Cannabis, Inc. (“Aurora”), a Canadian company (TSX: ACB.TO). When this
transaction closes, which is expected to occur in August of 2018, Aurora will acquire 100% of the outstanding shares of Anandia
in exchange for (i) free trading shares of Aurora common stock based on the 20-day volume weighted average trading price of the
Aurora stock for the 20 trading days immediately prior to June 11, 2018, and (ii) warrants with a five-year term to purchase one-half
of a share of Aurora common stock for each whole share of Aurora common stock received as part of the transaction. The number
and value of the shares of Aurora common stock and warrants that will be issued to 22nd Century in consideration for our Company’s
approximately 14.8% equity ownership of Anandia will not be known until the closing of the transaction, which is currently scheduled
to occur in August 2018. There is no guarantee that the transaction will be consummated.
NOTE 7. – FAIR VALUE MEASUREMENTS
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 June 30, 2018 and December 31, 2017, and indicates the fair value hierarchy
of the valuation techniques the Company utilized to determine such fair value:
|
|
Asset and Liabilities at Fair Value
|
|
|
|
As of June 30, 2018
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Certificate of deposit
|
|
$
|
-
|
|
|
$
|
3,000,000
|
|
|
$
|
-
|
|
|
$
|
3,000,000
|
|
Short-term investment securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money market funds
|
|
|
5,272,629
|
|
|
|
-
|
|
|
|
-
|
|
|
|
5,272,629
|
|
Corporate bonds
|
|
|
-
|
|
|
|
27,610,232
|
|
|
|
-
|
|
|
|
27,610,232
|
|
Commercial paper
|
|
|
-
|
|
|
|
2,443,160
|
|
|
|
-
|
|
|
|
2,443,160
|
|
U.S. treasury securities
|
|
|
-
|
|
|
|
5,985,640
|
|
|
|
-
|
|
|
|
5,985,640
|
|
U.S. government agency bonds
|
|
|
-
|
|
|
|
8,769,352
|
|
|
|
-
|
|
|
|
8,769,352
|
|
Total cash equivalents and short-term investment securities
|
|
$
|
5,272,629
|
|
|
$
|
47,808,384
|
|
|
$
|
-
|
|
|
$
|
53,081,013
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrant liability
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
167,779
|
|
|
$
|
167,779
|
|
|
|
Asset and Liabilities at Fair Value
|
|
|
|
As of December 31, 2017
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Certificate of deposit
|
|
$
|
-
|
|
|
$
|
3,000,000
|
|
|
$
|
-
|
|
|
$
|
3,000,000
|
|
Short-term investment securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Certificates of deposit
|
|
|
-
|
|
|
|
6,000,000
|
|
|
|
-
|
|
|
|
6,000,000
|
|
Money market funds
|
|
|
41,526,540
|
|
|
|
-
|
|
|
|
-
|
|
|
|
41,526,540
|
|
Corporate bonds
|
|
|
|
|
|
|
9,450,933
|
|
|
|
-
|
|
|
|
9,450,933
|
|
U.S. government agency bonds
|
|
|
-
|
|
|
|
1,998,040
|
|
|
|
-
|
|
|
|
1,998,040
|
|
Total cash equivalents and short-term investment securities
|
|
$
|
41,526,540
|
|
|
$
|
20,448,973
|
|
|
$
|
-
|
|
|
$
|
61,975,513
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrant liability
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
216,490
|
|
|
$
|
216,490
|
|
The warrant liability is measured at fair
value using certain estimated factors such as volatility and probability which are classified within Level 3 of the valuation hierarchy.
Significant unobservable inputs that are used in the fair value measurement of the Company’s derivative warrant liabilities
include volatility. Significant increases (decreases) in the volatility input would result in a significantly higher (lower) fair
value measurement.
NOTE 8. – NOTE 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. After the initial payment of $500,000, the balance remaining as of June
30, 2018 amounted to $675,226, with $390,016 and $285,210 reported as current and long-term portion of the note payable, respectively,
on the Company’s Consolidated Balance Sheets.
The cost of the of acquired license amount
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.
NOTE 9. - WARRANTS FOR COMMON STOCK
At June 30, 2018, the Company had outstanding
warrants to purchase 11,387,932 shares of common stock of the Company, of which warrants to purchase 94,721 shares contain an anti-dilution
feature. In July of 2018, the 94,721 warrants containing an anti-dilution feature were exercised on a cashless basis resulting
in the issuance of 63,832 shares of the Company’s common stock.
During the three and six months ended June
30, 2018, warrant holders exercised 0 and 700,148 warrants, respectively, on a cashless basis, resulting in the issuance of 0 and
426,180 shares, respectively.
During the year ended December 31, 2017,
the Company issued 11,293,211 warrants in conjunction with the June 2017 warrant exchange agreements. These warrants have an exercise
price equal to $2.15 per share and are exercisable for a period of six months from the date of issuance for a period of five (5)
years. See Note 3 for additional details.
During the year ended December 31, 2017,
warrant holders exercised 12,763,238 warrants, with 1,286,277 of such warrants being exercised on a cashless basis, resulting in
the issuance of an aggregate of 12,249,327 shares. Additionally, 223,814 warrants expired unexercised during the year ended December
31, 2017.
Outstanding warrants at June 30, 2018 consisted
of the following:
Warrant Description
|
|
Number of
Warrants
|
|
|
Exercise
Price
|
|
|
Expiration
|
|
|
|
|
|
|
|
|
|
August 2012 convertible NP warrants
(1) (2)
|
|
|
94,721
|
|
|
$
|
0.9310
|
|
|
August 8, 2018
|
June 2017 warrants pursuant to warrant exercise agreements
|
|
|
11,293,211
|
|
|
$
|
2.1500
|
|
|
December 20, 2022
|
|
|
|
|
|
|
|
|
|
|
|
Total warrants outstanding
|
|
|
11,387,932
|
|
|
|
|
|
|
|
(1)
|
|
Includes anti-dilution features.
|
(2)
|
|
Exercised on a cashless basis in July of 2018.
|
The Company estimates the value of warrant
liability upon issuance of the warrants and at each balance sheet date using the binomial lattice model to allocate total enterprise
value to the warrants and other securities in the Company’s capital structure. Volatility was estimated based on historical
observed equity volatilities and implied (forward) or expected volatilities for a sample group of guideline companies and consideration
of recent market trends.
The following table is a roll-forward summary
of the warrant liability since December 31, 2016:
Fair value at December 31, 2016
|
|
$
|
58,681
|
|
Loss as a result of change in fair value
|
|
|
157,809
|
|
Fair value at December 31, 2017
|
|
|
216,490
|
|
Gain as result of change in fair value
|
|
|
(48,711
|
)
|
Fair value at June 30, 2018
|
|
$
|
167,779
|
|
The aggregate net gain (loss) as a result
of the Company’s warrant liability for the three and six months ended June 30, 2018 amounted to $0 and $48,711, respectively
(the aggregate net loss for the three and six months ended June 30, 2017 amounted to $77,583 and $82,927, respectively), which
are included in Other income (expense) under Warrant liability gain (loss) - net in the accompanying Consolidated Statements of
Operations and Comprehensive Loss.
The following table summarizes the
Company’s warrant activity since December 31, 2016:
|
|
Number of
Warrants
|
|
Warrants outstanding at December 31, 2016
|
|
|
13,781,921
|
|
Warrants exercised during 2017
|
|
|
(1,470,027
|
)
|
Warrants expired during 2017
|
|
|
(223,814
|
)
|
Warrants issued pursuant to June 2017 warrant exercise agreements
|
|
|
11,293,211
|
|
Warrants exercised pursuant to June 2017 warrant exercise agreements
|
|
|
(11,293,211
|
)
|
Warrants outstanding at December 31, 2017
|
|
|
12,088,080
|
|
Warrants exercised during 2018
|
|
|
(700,148
|
)
|
Warrants outstanding at June 30, 2018
|
|
|
11,387,932
|
|
|
|
|
|
|
Composition of outstanding warrants:
|
|
|
|
|
Warrants containing anti-dilution feature
|
|
|
94,721
|
|
Warrants without anti-dilution feature
|
|
|
11,293,211
|
|
|
|
|
11,387,932
|
|
NOTE 10. - 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 Loss. The amounts expensed during the three
and six months ended June 30, 2018 were $83,838 and $221,070, respectively ($56,250 and $119,640 for the three and six months ended
June 30, 2017, 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 and six months ended June 30, 2018, the aggregate
costs incurred related to capitalized patent costs and patent maintenance expense amounted to $4,845 and $34,107, respectively
($4,866 and $31,709 for the three and six months ended June 30, 2017, respectively).
On December 8, 2015, the Company entered
into an additional license agreement (the “License”) with NCSU. Under the terms of the License, the Company paid NCSU
a non-refundable, non-creditable lump sum license fee of $150,000. Additionally, the License calls for the Company to pay NCSU
a non-refundable, non-creditable minimum annual royalty beginning on December 31, 2018 in the amount of $10,000. The minimum annual
royalty payment increases to $15,000 in 2019, $25,000 in 2020 and 2021, and $50,000 per year thereafter for the remaining term
of the License. The Company is also responsible for reimbursing NCSU for actual third-party patent costs incurred. During the three
and six months ended June 30, 2018, the aggregate costs incurred related to capitalized patent costs and patent maintenance expense
amounted to $79 and $79, respectively ($199 and $29,866 for the three and six months ended June 30, 2017). This License continues
through the life of the last-to-expire patent, expected to be in 2036.
On February 10, 2014, the Company entered
into a sponsored research and development agreement (the “Agreement”) with NCSU. Under the terms of the Agreement,
the Company paid NCSU $162,408 over the two-year term of the Agreement, which grants certain licensed rights to the Company. The
Company had extended the Agreement through January 31, 2017 at an additional cost of $85,681. In February 2018, the Company finalized
an additional extension to this Agreement through April 30, 2018 at a cost of $88,344. In May 2018, the Company finalized an additional
extension to this Agreement through April 30, 2019 at a total cost of $121,357.
License agreements -
Additionally,
the Company has entered into the following four 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 $24,505 and $49,011 for the
three and six months ended June 30, 2018, respectively ($24,505 and $49,011 for the three and six months ended June 30, 2017),
and was included in Amortization expense on the Company’s Consolidated Statements of Operations and Comprehensive Loss.
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 8 – Note 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. A
patent was issued during the first quarter of 2017 under this clause, and accordingly, the $75,000 was due and payable to NCSU.
The $75,000 cost was included in Research and development costs on the Company’s Consolidated Statements of Operations and
Comprehensive Loss for the three months ended March 31, 2017 and the six months ended June 30, 2017. Additionally, the License
Agreement calls for the Company to pay NCSU three non-refundable, non-creditable license maintenance fees in the amount of $15,000
per annum in each of December 2015, 2016 and 2017. The Company is obligated to pay to NCSU an annual minimum royalty fee of $20,000
in 2018, $30,000 in 2019, and $50,000 per year thereafter for the remaining term of the License Agreement. The Company is also
responsible for reimbursing NCSU for actual third-party patent costs incurred. During the three and six months ended June 30, 2018,
the aggregated costs incurred related to capitalized patent costs and patent maintenance expense amounted to $4,995 and $9,465,
respectively ($5,173 and $24,242 for the three and six months ended June 30, 2017, 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.
Other research agreements -
Further, the Company has entered into the following three agreements relating to sponsored research. Costs associated with these
agreements are expensed when incurred in Research and development costs on the Company’s Consolidated Statements of Operations
and Comprehensive Loss.
On September 28, 2015, the Company’s
wholly-owned subsidiary, Botanical Genetics, entered into a Sponsored Research Agreement (the “Agreement”) with Anandia
Laboratories Inc. (“Anandia”). Pursuant to the Agreement, Anandia is conducting research on behalf of the Company relating
to the hemp/cannabis plant. The Agreement had an initial term of twelve (12) months from the date of the Agreement and could be
extended at the sole option of the Company for two (2) additional periods of twelve (12) months each (of which the option on the
first twelve (12) month period has been extended). The Company paid Anandia $379,800 over the initial term of the Agreement. On
March 13, 2017, the Company entered into Amendment No. 1 to the Agreement (the “Amendment”). The Amendment has a term
of twelve (12) months and calls for the Company to pay Anandia a total of $785,100 in equal monthly installments of $65,425. During
the three and six months ended June 30, 2018, expenses related to the Agreement amounted to $0 and $130,850, respectively ($196,275
and $261,700 for the three and six months ended June 30, 2017, respectively), and are included in Research and development costs
on the Company’s Consolidated Statements of Operations and Comprehensive Loss. Under the terms of the Agreement, the Company
will have co-exclusive worldwide rights with Anandia to all the intellectual property resulting from the sponsored research between
the Company and Anandia. The party that commercializes such intellectual property in the future will pay royalties in varying amounts
to the other party, with the amount of such royalties being dependent upon the type of products that are commercialized in the
future. If either party sublicenses such intellectual property to a third-party, then the Company and Anandia will share equally
in such sublicensing consideration. The Amendment expired on March 12, 2018 and the Company is in negotiations with Anandia regarding
exercising its option on the second of the additional twelve (12) month extensions.
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 and six months ended June 30, 2018, expenses related to the agreements amounted to
$76,211 and $180,178, respectively ($70,729 and $111,574 for the three and six months ended June 30, 2017, respectively), and are
included in Research and development costs on the Company’s Consolidated Statements of Operations and Comprehensive Loss.
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 second quarter of 2018, the Company recorded a R&D expense related to this Agreement in the amount
of $25,000.
Lease Agreements
- The Company
leases a manufacturing facility and warehouse located in North Carolina on a triple net lease basis. The lease commenced on January
14, 2014 and had an initial term of twelve (12) months. The lease contains four (4) additional extensions; with one lease extension
being for an additional one (1) year and with the other three (3) lease extensions each being for an additional two (2) years in
duration, exercisable at the option of the Company. The Company is currently in the second two-year lease extension term that will
expire on October 31, 2019. The lease expense for the three and six months ended June 30, 2018 amounted to approximately $42,000
and $85,000, respectively (approximately $38,000 and $77,000 for the three and six months ended June 30, 2017, respectively). The
future minimum annual lease payments if the Company exercises each of the additional extensions are approximately as follows:
Year ended December 31, 2018 -
|
|
$
|
85,000
|
|
Year ended December 31, 2019 -
|
|
$
|
169,000
|
|
Year ended December 31, 2020 -
|
|
$
|
169,000
|
|
Year ended December 31, 2021 -
|
|
$
|
141,000
|
|
On August 14, 2017, the Company entered
into a lease for warehouse space in North Carolina to store and operate tobacco leaf processing equipment, to store the Company’s
proprietary tobacco leaf and to store inventory used in the Company’s contract manufacturing business. The lease calls for
a monthly payment of $4,665, expires on August 14, 2018 and contains twelve-month renewal options as long as the Company continues
to lease the warehouse. Future minimum lease payments will be approximately $56,000 per year for each subsequent year the warehouse
space is leased by the Company.
On October 4, 2017, the Company entered
a lease for office space at a location in Williamsville, New York with an initial three-year term and with a monthly lease payment
of $6,375. The Company moved into the leased space in February of 2018. Future minimum annual lease payments under the new office
lease will be approximately $38,000, $76,000 and $76,000 for the years ending on December 31, 2018, 2019 and 2020, respectively.
On May 1, 2016, the Company entered into
a sublease for laboratory space in Buffalo, New York. The sublease called for a monthly payment of $1,471 through April 30, 2018.
Additionally, on February 1, 2017, the Company entered into an amendment to the initial sublease calling for the sublease of additional
lab space at a cost of $1,219 per month, bringing the total monthly sublease obligation to $2,690. On April 26, 2017, the Company
entered into an amendment to the sublease to extend the term of the sublease for an additional twelve (12) months, commencing on
May 1, 2017 at a total cost of $2,770 per month for the total lease obligation. On February 21, 2018, the Company entered into
a new sublease amendment that further increased the lab space, extended the sublease term through June 30, 2019 and calls for a
monthly sublease payment of $5,706 beginning on March 1, 2018. Future minimum sublease payments for the years ending on December
31, 2018 and 2019 will be approximately $34,000 and $34,000, respectively.
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 and six months ended June 30, 2018,
the Company incurred expenses relating to these contracts in the approximate amount of $2,725,000 and $4,021,000, respectively.
There were no expenses incurred relating to the MRTP Application for the three and six months ended June 30, 2017. Future financial
commitments under these contracts are estimated to amount to approximately an additional $7,500,000 and are expected to be completed
over the next six to nine 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.
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 now 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 is to file its partial summary judgment motion by August 20, 2018, after which Crede
is required to file its response by September 20, 2018, after which the Company will then be required to file its reply to Crede’s
response by October 14, 2018.
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.
NOTE 11. - LOSS PER COMMON SHARE
The following table sets forth the computation
of basic and diluted loss per common share for the three-month periods ended June 30, 2018 and 2017, respectively:
|
|
June 30,
2018
|
|
|
June 30,
2017
|
|
|
|
|
|
|
|
|
Net loss attributed to common shareholders
|
|
$
|
(6,738,652
|
)
|
|
$
|
(3,355,624
|
)
|
|
|
|
|
|
|
|
|
|
Denominator for basic loss per share-weighted average shares outstanding
|
|
|
124,311,087
|
|
|
|
91,577,688
|
|
|
|
|
|
|
|
|
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
Warrants and options outstanding
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Denominator for diluted loss per common share-weighted
average shares adjusted for dilutive securities
|
|
|
124,311,087
|
|
|
|
91,577,688
|
|
|
|
|
|
|
|
|
|
|
Net loss per common share - basic and diluted
|
|
$
|
(0.05
|
)
|
|
$
|
(0.04
|
)
|
The following table sets forth the computation
of basic and diluted loss per common share for the six-month periods ended June 30, 2018 and 2017, respectively:
|
|
June 30,
2018
|
|
|
June 30,
2017
|
|
|
|
|
|
|
|
|
Net loss attributed to common shareholders
|
|
$
|
(5,352,164
|
)
|
|
$
|
(5,976,901
|
)
|
|
|
|
|
|
|
|
|
|
Denominator for basic loss per share-weighted average shares outstanding
|
|
|
124,166,321
|
|
|
|
91,165,770
|
|
|
|
|
|
|
|
|
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
Warrants and options outstanding
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Denominator for diluted loss per common share-weighted average shares adjusted for dilutive securities
|
|
|
124,166,321
|
|
|
|
91,165,770
|
|
|
|
|
|
|
|
|
|
|
Net loss per common share - basic and diluted
|
|
$
|
(0.04
|
)
|
|
$
|
(0.07
|
)
|
Dilutive securities outstanding at June
30, 2018 and 2017, respectively, are presented below. Securities outstanding were excluded from the computation of loss per share
because they would have been anti-dilutive.
|
|
June 30,
2018
|
|
|
June 30,
2017
|
|
Warrants
|
|
|
11,387,932
|
|
|
|
12,445,247
|
|
Options
|
|
|
8,756,560
|
|
|
|
6,965,688
|
|
|
|
|
20,144,492
|
|
|
|
19,410,935
|
|
NOTE 12. – 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 June
30, 2018, the Company had available 1,802,115 shares remaining for future awards under the OIP.
During the six months ended June 30, 2018,
the Company issued stock option awards from the OIP for 1,431,841 shares to eligible individuals. Stock options issued to acquire
1,131,841 shares of Company common stock have vesting periods ranging from one to three years from the date of the award, and stock
options issued to acquire 300,000 shares of Company common stock were scheduled to vest upon the attainment of various milestones.
During the six months ended June 30, 2017, the Company issued stock option awards from the OIP for 1,372,000 shares to eligible
individuals having vesting periods ranging from one to three years from the date of the award. All stock option awards were valued
using the Black-Scholes option-pricing model on the date of the award.
For the three and six months ended June
30, 2018, the Company recorded compensation expense related to stock option awards granted under the OIP of $1,682,228 and $2,246,104,
respectively ($154,004 and $322,983 for the three and six months ended June 30, 2017, respectively).
As of June 30, 2018, unrecognized compensation
expense related to non-vested stock options amounted to approximately $3,644,000, which is expected to be recognized as follows:
$943,000, $1,113,000, $698,000 and $98,000 during 2018, 2019, 2020 and 2021, respectively. Approximately $792,000 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 Company’s Senior Vice President
of Science and Regulatory Affairs, James E. Swauger, Ph.D., died on April 19, 2018. As a result, stock options to purchase a total
of 900,000 shares of the Company’s common stock with an exercise price of $2.12 per share granted to Dr. Swauger on October
31, 2017 vested upon his death and are exercisable by Dr. Swauger’s beneficiaries for a period of one year from the date
of his death. Additional stock options to purchase a total of 300,000 shares of the Company’s common stock with an exercise
price of $2.12 per share granted to Dr. Swauger on October 31, 2017 were to vest based on the achievement of certain milestones
by Dr. Swauger, and accordingly, will not vest and were cancelled. The unrecognized fair value of Dr. Swauger’s subject stock
options to purchase 900,000 shares at the time of his death was $1,226,825 and was recognized as equity-based compensation during
the second quarter of 2018. The unrecognized fair value of Dr. Swauger’s subject stock options to purchase 300,000 shares
was $443,006.
The fair value of each option grant is estimated
on the date of grant using the Black-Scholes option-pricing model. The following assumptions were used for the six months ended
June 30, 2018 and 2017:
|
|
2018
|
|
|
2017
|
|
Risk-free interest rate (weighted average)
|
|
|
2.97
|
%
|
|
|
2.12
|
%
|
Expected dividend yield
|
|
|
0
|
%
|
|
|
0
|
%
|
Expected stock price volatility
|
|
|
90
|
%
|
|
|
90
|
%
|
Expected life of options (weighted average)
|
|
|
5.55 years
|
|
|
|
5.13 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, 2016 is as follows:
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Remaining
|
|
|
Aggregate
|
|
|
|
Number of
|
|
|
Exercise
|
|
|
Contractual
|
|
|
Intrinsic
|
|
|
|
Options
|
|
|
Price
|
|
|
Term
|
|
|
Value
|
|
Outstanding at December 31, 2016
|
|
|
5,650,679
|
|
|
$
|
1.04
|
|
|
|
|
|
|
|
|
|
Granted in 2017
|
|
|
2,692,000
|
|
|
$
|
1.76
|
|
|
|
|
|
|
|
|
|
Exercised in 2017
|
|
|
(85,988
|
)
|
|
$
|
0.79
|
|
|
|
|
|
|
|
|
|
Expired in 2017
|
|
|
(100,000
|
)
|
|
$
|
1.43
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2017
|
|
|
8,156,691
|
|
|
$
|
1.28
|
|
|
|
|
|
|
|
|
|
Granted in 2018
|
|
|
1,431,841
|
|
|
$
|
2.66
|
|
|
|
|
|
|
|
|
|
Exercised in 2018
|
|
|
(327,781
|
)
|
|
$
|
0.81
|
|
|
|
|
|
|
|
|
|
Expired / cancelled in 2018
|
|
|
(504,191
|
)
|
|
$
|
1.71
|
|
|
|
|
|
|
|
|
|
Outstanding at June 30, 2018
|
|
|
8,756,560
|
|
|
$
|
1.50
|
|
|
|
6.2 years
|
|
|
$
|
8,516,505
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at June 30, 2018
|
|
|
5,237,804
|
|
|
$
|
1.32
|
|
|
|
4.8 years
|
|
|
$
|
5,693,556
|
|
The weighted average grant date fair value
of options issued during the six months ended June 30, 2018 and 2017 was $1.80 and $0.97, respectively. The total fair value of
options that vested during the six months ended June 30, 2018 and 2017 amounted to $2,306,867 and $684,265, respectively. There
were 327,781 options exercised on a cash and cashless basis during the six months ended June 30, 2018 resulting in the issuance
of 315,540 shares and proceeds of $217,500 to the Company. There were 56,991 options exercised on a cashless basis during the six
months ended June 30, 2017 resulting in the issuance of 34,953 shares of the Company’s common stock.