Quarterly Report (10-q)

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Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE

COMMISSION WASHINGTON, D.C. 20549

FORM 10-Q


☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2022


☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period From ________ to ________

Commission File Number: 001-36338

22nd Century Group, Inc.

(Exact name of registrant as specified in its charter)

Nevada		98-0468420
(State or other jurisdiction		(IRS Employer
of incorporation)		Identification No.)

500 Seneca Street, Suite 507, Buffalo, New York 14204

(Address of principal executive offices)

(716) 270-1523

(Registrant’s telephone number, including area code)

Securities registered under Section 12(b) of the Act:

Title of each class		Ticker symbol		Name of Exchange on Which Registered
Common Stock, $0.00001 par value		XXII		NASDAQ Capital Market

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.

Yes ⌧ No ◻

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes ⌧ No ◻

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.


Large accelerated filer	☒	Accelerated filer	☐
Non-accelerated filer	☐	Smaller reporting company	☐
		Emerging growth company	☐

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).

Yes ☐ No ☒

As of November 5, 2022, there were 215,301,603 shares of common stock issued and outstanding.

Table of Contents

22nd CENTURY GROUP, INC.

INDEX


		Page Number
PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets as of September 30, 2022 and December 31, 2021 (unaudited)	3

	Condensed Consolidated Statements of Operations and Comprehensive Loss for the Three and Nine Months ended September 30, 2022 and 2021 (unaudited)	4

	Condensed Consolidated Statements of Changes in Shareholders’ Equity for the Three and Nine Months ended September 30, 2022 and 2021 (unaudited)	5

	Condensed Consolidated Statements of Cash Flows for the Nine Months ended September 30, 2022 and 2021 (unaudited)	6

	Notes to Condensed Consolidated Financial Statements (unaudited)	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	29

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	38

Item 4.	Controls and Procedures	38

PART II.	OTHER INFORMATION	40

Item 1.	Legal Proceedings	40

Item 1A.	Risk Factors	40

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	40

Item 3.	Default Upon Senior Securities	40

Item 4.	Mine Safety Disclosures	40

Item 5.	Other Information	40

Item 6.	Exhibits	41

SIGNATURES		42

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22nd CENTURY GROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(amounts in thousands, except share and per-share data)


	September 30,		December 31,
	2022		2021
ASSETS
Current assets:
Cash and cash equivalents	$	2,364	$	1,336
Short-term investment securities		41,357		47,400
Accounts receivable, net		4,953		585
Inventory		12,264		2,881
Prepaid expenses and other current assets		3,463		2,183
Total current assets		64,401		54,385
Property, plant and equipment, net		18,279		5,841
Operating lease right-of-use assets, net		2,429		1,723
Goodwill		33,748		—
Intangible assets, net		18,336		7,919
Investments		981		2,345
Other assets		4,002		3,741
Total assets	$	142,176	$	75,954

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Notes and loan payable	$	5,825	$	596
Operating and finance lease obligations		927		308
Accounts payable		5,787		2,173
Accrued expenses		2,468		1,489
Accrued payroll		1,043		2,255
Accrued excise taxes and fees		1,525		1,270
Deferred income		693		119
Other current liabilities		397		217
Total current liabilities		18,665		8,427
Long-term liabilities:
Notes payable		220		—
Operating and finance lease obligations		1,592		1,432
Other long-term liabilities		611		21
Total liabilities		21,088		9,880
Commitments and contingencies (Note 9)
Shareholders' equity
Preferred stock, $.00001 par value, 10,000,000 shares authorized
Common stock, $.00001 par value, 300,000,000 shares authorized
Capital stock issued and outstanding:
215,301,603 common shares (162,872,875 at December 31, 2021)
Common stock, par value		2		2
Capital in excess of par value		333,124		244,247
Accumulated other comprehensive loss		(507)		(162)
Accumulated deficit		(211,531)		(178,013)
Total shareholders' equity		121,088		66,074
Total liabilities and shareholders’ equity	$	142,176	$	75,954

See accompanying notes to unaudited interim condensed consolidated financial statements.

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22nd CENTURY GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(Unaudited)

(amounts in thousands, except per-share data)


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2022		2021		2022		2021
Revenue, net	$	19,383	$	7,811	$	42,905	$	22,988
Cost of goods sold		18,764		7,519		41,086		21,733
Gross profit		619		292		1,819		1,255
Operating expenses:
Sales, general and administrative		14,569		6,830		31,355		17,846
Research and development		1,318		1,031		4,355		2,789
Total operating expenses		15,887		7,861		35,710		20,635
Operating loss		(15,268)		(7,569)		(33,891)		(19,380)
Other income (expense):
Unrealized loss on investments		(345)		(1,900)		(2,046)		(2,040)
Gain on Panacea investment conversion		—		—		—		2,548
Realized loss on short-term investment securities		(35)		—		(143)		—
Interest income, net		113		52		211		272
Interest expense		(148)		(23)		(230)		(44)
Total other income (expense)		(415)		(1,871)		(2,208)		736
Loss before income taxes		(15,683)		(9,440)		(36,099)		(18,644)
Benefit for income taxes		(2,581)		—		(2,581)		—
Net loss	$	(13,102)	$	(9,440)	$	(33,518)	$	(18,644)

Net loss per common share - basic and diluted	$	(0.06)	$	(0.06)	$	(0.18)	$	(0.12)
Weighted average common shares outstanding - basic and diluted (in thousands)		210,131	$	162,721	$	185,269	$	153,998

Other comprehensive loss:
Unrealized loss on short-term investment securities		(19)		(28)		(488)		(101)
Reclassification of losses to net loss		35		—		143		—
Other comprehensive income (loss)		16		(28)		(345)		(101)
Comprehensive loss	$	(13,086)	$	(9,468)	$	(33,863)	$	(18,745)

See accompanying notes to unaudited interim condensed consolidated financial statements.

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22nd CENTURY GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

(amounts in thousands)


	Nine Months Ended September 30, 2022
						Accumulated
	Common	Par Value		Capital in		Other				Total
	Shares	of Common		Excess of		Comprehensive		Accumulated		Shareholders’
	Outstanding	Shares		Par Value		Income (Loss)		Deficit		Equity
Balance at January 1, 2022	162,872,875	$	2	$	244,247	$	(162)	$	(178,013)	$	66,074
Stock issued in connection with RSU vesting	1,663,691		—		—		—		—		—
Equity-based compensation	—		—		1,213		—		—		1,213
Unrealized loss on short-term investment securities	—		—		—		(400)		—		(400)
Net loss	—		—		—		—		(8,918)		(8,918)
Balance at March 31, 2022	164,536,566		2		245,460		(562)		(186,931)		57,969
Stock issued in connection with RSU vesting	75,000		—		—		—		—		—
Stock issued in connection with option exercises	150,000		—		174		—		—		174
Stock issued in connection with acquisition	32,900,000		—		51,653		—		—		51,653
Equity-based compensation	—		—		1,106		—		—		1,106
Unrealized loss on short-term investment securities	—		—		—		(69)		—		(69)
Reclassification of losses to net loss	—		—		—		108		—		108
Net loss	—		—		—		—		(11,498)		(11,498)
Balance at June 30, 2022	197,661,566	$	2	$	298,393	$	(523)	$	(198,429)	$	99,443
Stock issued in connection with RSU vesting	566,862		—		—		—		—		—
Stock issued in connection with capital raise, net of issuance costs of 2,516	17,073,175		—		32,484		—		—		32,484
Equity-based compensation	—		—		2,247		—		—		2,247
Unrealized loss on short-term investment securities	—		—		—		(19)		—		(19)
Reclassification of losses to net loss	—		—		—		35		—		35
Net loss	—		—		—		—		(13,102)		(13,102)
Balance at September 30, 2022	215,301,603	$	2	$	333,124	$	(507)	$	(211,531)	$	121,088


	Nine Months Ended September 30, 2021
						Accumulated
	Common	Par Value		Capital in		Other				Total
	Shares	of Common		Excess of		Comprehensive		Accumulated		Shareholders’
	Outstanding	Shares		Par Value		Income (Loss)		Deficit		Equity
Balance at January 1, 2021	139,061,690	$	1	$	189,439	$	74	$	(145,404)	$	44,110
Stock issued in connection with RSU vesting	1,196,258		—		—		—		—		—
Stock issued in connection with option exercises	846,342		—		1,153		—		—		1,153
Stock issued in connection with warrant exercises	11,293,211		1		11,781		—		—		11,782
Equity-based compensation	—		—		507		—		—		507
Unrealized loss on short-term investment securities	—		—		—		(32)		—		(32)
Net loss	—		—		—		—		(5,030)		(5,030)
Balance at March 31, 2021	152,397,501	$	2	$	202,880	$	42	$	(150,434)	$	52,490
Stock issued in connection with RSU vesting, net of shares withheld for taxes	200,103		—		(469)		—		—		(469)
Stock issued in connection with option exercises	87,879		—		106		—		—		106
Stock issued in connection with capital raise, net of issuance costs of 1,794	10,000,000		—		38,206		—		—		38,206
Equity-based compensation	—		—		1,245		—		—		1,245
Unrealized loss on short-term investment securities	—		—		—		(41)		—		(41)
Net loss	—		—		—		—		(4,174)		(4,174)
Balance at June 30, 2021	162,685,483	$	2	$	241,968	$	1	$	(154,608)	$	87,363
Stock issued in connection with RSU vesting	50,000		—		—		—		—		—
Equity-based compensation	—		—		1,119		—		—		1,119
Unrealized loss on short-term investment securities	—		—		—		(28)		—		(28)
Net loss	—		—		—		—		(9,440)		(9,440)
Balance at September 30, 2021	162,735,483	$	2	$	243,087	$	(27)	$	(164,048)	$	79,014

See accompanying notes to unaudited interim condensed consolidated financial statements.

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22nd CENTURY GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(amounts in thousands)


	Nine Months Ended
	September 30,
	2022		2021
Cash flows from operating activities:
Net loss	$	(33,518)	$	(18,644)
Adjustments to reconcile net loss to cash used in operating activities:
Amortization and depreciation		1,992		932
Amortization of right-of-use asset		525		214
Amortization of inventory step-up		978		—
Unrealized loss on investment		2,046		2,040
Realized loss on short-term investment securities		143		—
Gain on Panacea investment conversion		—		(2,548)
Accretion of non-cash interest expense (income), net		213		13
Equity-based employee compensation expense		4,566		2,871
Deferred income taxes		(2,581)		—
Changes in operating assets and liabilities, net of acquisition:
Accounts receivable		(1,425)		980
Inventory		(5,068)		(669)
Prepaid expenses and other assets		(934)		(1,494)
Accounts payable		1,933		289
Accrued expenses		(56)		880
Accrued payroll		(1,408)		(1,884)
Accrued excise taxes and fees		255		(418)
Other liabilities		(309)		(769)
Net cash used in operating activities		(32,648)		(18,207)
Cash flows from investing activities:
Acquisition of patents, trademarks, and licenses		(394)		(239)
Acquisition of property, plant and equipment		(2,501)		(470)
Acquisition, net of cash acquired and debt assumed		(1,297)		—
Investment in Change Agronomy Ltd.		(682)		—
Sales and maturities of short-term investment securities		67,315		52,203
Purchase of short-term investment securities		(62,061)		(84,701)
Net cash provided by (used in) investing activities		380		(33,207)
Cash flows from financing activities:
Payment on note payable		(1,508)		(1,417)
Proceeds from note payable issuance		2,162		2,653
Other financing activities		(16)		—
Net proceeds from option exercise		174		1,259
Net proceeds from warrant exercise		—		11,782
Proceeds from issuance of common stock		35,000		40,000
Payment of common stock issuance costs		(2,516)		(1,794)
Taxes paid related to net share settlement of RSUs		—		(469)
Net cash provided by financing activities		33,296		52,014
Net increase in cash and cash equivalents		1,028		600
Cash and cash equivalents - beginning of period		1,336		1,029
Cash and cash equivalents - end of period	$	2,364	$	1,629

Supplemental disclosures of cash flow information:
Non-cash transactions:
Patent and trademark additions included in accounts payable	$	64	$	35
Property, plant and equipment additions included in accounts payable	$	38	$	4
Property, plant and equipment additions included in accrued expenses	$	—	$	10
Right-of-use assets and corresponding operating lease obligations	$	—	$	497
Patent and trademark additions included in accrued expenses	$	62	$	22
Panacea investment conversion	$	—	$	12,485
Stock issued in connection with acquisition	$	51,653	$	—

See accompanying notes to unaudited interim condensed consolidated financial statements.

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22nd CENTURY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2022

(Unaudited)

Amounts in thousands, except for share and per-share data

NOTE 1. - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation - The accompanying unaudited Condensed 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 nine months ended September 30, 2022 are not necessarily indicative of the results that may be expected for the year ending December 31, 2022. The balance sheet as of December 31, 2021 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 condensed consolidated financial statements should be read in conjunction with the December 31, 2021 audited consolidated financial statements and the notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2021, as filed with the Securities and Exchange Commission on March 1, 2022.

Principles of Consolidation - The accompanying Condensed Consolidated Financial Statements include the accounts of (i) 22nd Century Group, Inc. (“22nd Century Group”); (ii) its five wholly-owned subsidiaries, 22nd Century Limited, LLC (“22nd Century Ltd”), NASCO Products, LLC (“NASCO”), Botanical Genetics, LLC (“Botanical Genetics”), 22nd Century Group Canada, Inc. (“22nd Century Group Canada”) and 22nd Century Group Europe B.V. (“22nd Century Group Europe”); (iii) two wholly-owned subsidiaries of 22nd Century Ltd, Goodrich Tobacco Company, LLC (“Goodrich Tobacco”) and Heracles Pharmaceuticals, LLC (“Heracles Pharma”); and (iv) two wholly-owned subsidiaries of Botanical Genetics, 22nd Century Holdings, LLC (“22nd Century Holdings”) and Golden Acquisition Sub, LLC. This group of subsidiaries is referred to as collectively with 22nd Century Group as the “Company”. All intercompany accounts and transactions have been eliminated.

Nature of Business – 22nd Century Group is a leading agricultural biotechnology and intellectual property company focused on tobacco harm reduction, reduced nicotine tobacco and improving health and wellness through plant science. 22nd Century Ltd performs research and development related to the level of nicotine and other nicotinic alkaloids in tobacco plants and Botanical Genetics performs research and development related to hemp/cannabis plants. Goodrich Tobacco and Heracles Pharma are business units for the Company’s potential modified exposure tobacco products. 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. 22nd Century Holdings owns and operates Needle Rock Farms. 22nd Century Group Canada and 22nd Century Group Europe were formed for future international business opportunities. As described in Note 2, on May 13, 2022, the Company acquired through Golden Acquisition Sub, LLC substantially all of the assets of GVB Biopharma’s (“GVB”) business dedicated to hemp-based cannabinoid extraction, refinement, contract manufacturing and product development, which allows the Company to leverage its expertise in receptor and plant science to develop its hemp/cannabis franchise and add significant scale in the immediate term.

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Reclassifications – As a result of the acquisition of GVB (see Note 2), the Company has revised the presentation and classification of depreciation and amortization in the Condensed Consolidated Statement of Operations and Comprehensive Loss to conform with the acquiree, as follows:


	Three Months Ended						Nine Months Ended
	September 30, 2021						September 30, 2021
	As originally						As originally
	reported		Reclass		Revised		reported		Reclass		Revised
Revenue, net	$	7,811	$	—	$	7,811	$	22,988	$	—	$	22,988
Cost of goods sold		7,362		157		7,519		21,306		427		21,733
Gross profit		449		(157)		292		1,682		(427)		1,255
Operating expenses:
Sales, general and administrative		6,821		9		6,830		17,827		19		17,846
Research and development		856		175		1,031		2,303		486		2,789
Depreciation		173		(173)		—		461		(461)		—
Amortization		168		(168)		—		471		(471)		—
Total operating expenses		8,018		(157)		7,861		21,062		(427)		20,635
Operating loss	$	(7,569)	$	—	$	(7,569)	$	(19,380)	$	—	$	(19,380)

COVID-19 Pandemic – The COVID-19 pandemic has had a minimal impact on the Company’s operations in 2021 and thus far in 2022, but there is a risk that state and federal authorities’ responses to the COVID-19 pandemic or another pandemic may disrupt our business in the future. Our executive leadership team and staff are monitoring this evolving situation and its impacts on our business. We will continue to monitor the local, state, and federal guidance regarding our business practices.

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.

Inventories - Inventories are valued at the lower of historical cost or net realizable value. Cost is determined using an average cost method for tobacco leaf inventory and raw materials inventory. Standard cost is primarily used for finished goods inventory. Cost of hemp biomass consists of initial third-party acquisition costs plus analytical testing costs. Costs of extracted and hemp oil inventory are comprised of initial acquisition cost of the biomass and all direct and indirect processing costs including labor related costs, consumables, materials, packaging supplies, utilities, facility costs, analytical testing costs, and production related depreciation. 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.

Acquisitions - The Company accounts for acquisitions under the acquisition method of accounting for business combinations. Results of operations of acquired companies are included in the Company’s results of operations as of the respective acquisition dates. The purchase price of each acquisition is allocated to the net assets acquired based on estimates of their fair values at the date of the acquisition. Any purchase price in excess of these net assets is recorded as goodwill.

All direct acquisition-related costs are expensed as incurred and are recognized in operating expenses on the Company’s Condensed Consolidated Statements of Operations and Comprehensive Loss. The allocation of purchase price in certain cases may be subject to revision based on the final determination of fair values during the measurement period, which may be up to one year from the acquisition date.

Goodwill - Goodwill represents the excess of cost over the fair value of identifiable net assets of a business acquired and is assigned to one or more reporting units. The Company’s reporting unit is the same as its reportable segment, which is the consolidated entity. The Company tests its reporting unit’s goodwill for impairment at least annually as of the measurement date year and between annual tests if an event occurs or circumstances change that would more-likely-than-not reduce the fair value of a reporting unit below its carrying amount.

During the nine months ended September 30, 2022, there were no indicators of impairment and accordingly a goodwill impairment test was not performed.

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Intangible Assets – Intangible assets recorded at fair value as a component of purchase accounting consist of purchased customer relationships and tradename. Definite lived intangible assets related to customer relationship is amortized on an accelerated basis, which approximates the projected cash flows used to determine the fair value of the definite-lived intangible assets at the time of acquisition. The tradename asset is considered indefinite-lived and is not amortized.

Other definite lived 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 rights to use.

The Company’s capitalized intellectual property costs are amortized using the straight-line method over the remaining statutory life of the patent assets in each of the Company’s patent families, which have estimated expiration dates ranging from 2026 to 2043. 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 have expected expiration dates from 2028 through 2036. The Company believes that costs associated with becoming a signatory to the MSA, costs related to the acquisition of a predicate cigarette brand and trademarks have indefinite lives. As such, no amortization is taken. At each reporting period, the Company evaluates whether events and circumstances continue to support the indefinite-lived classification.

Impairment of Long-Lived Assets – On at least an annual basis, 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. If any such indicators are present, the Company will test for recoverability in accordance with ASC 360-Property, plant, and equipment or ASC 350- Intangibles, Goodwill, and Other.

Intangible assets subject to amortization are reviewed for strategic importance and commercialization opportunity prior to expiration. If it is determined that the asset no longer supports the Company’s strategic objectives and/or will not be commercially viable prior to expiration, the asset is impaired. In addition, the Company will assess the expected future undiscounted cash flows for its intellectual property based on consideration of future market and economic conditions, competition, federal and state regulations, and licensing opportunities. If the carrying value of such assets are not recoverable, the carrying value will be reduced to fair value and record the difference as an impairment.

Indefinite-lived intangible asset carrying values are reviewed at least annually or more frequently if events or changes in circumstances indicate that it is more likely than not that an impairment exists. The Company first performs a qualitative assessment and considers its current strategic objectives, future market and economic conditions, competition, and federal and state regulations to determine if an impairment is more likely than not. If it is determined that an impairment is more likely than not, a quantitative assessment is performed to compare the asset carrying value to fair value and record the difference as an impairment.

Fair Value of Financial Instruments – 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 Company estimates that the carrying amounts reported on the Condensed Consolidated Balance Sheets for cash and cash equivalents, accounts receivable, contract assets, promissory note receivable, accounts payable and accrued expenses, and notes and loans payable approximate their fair value due to the short-term nature of these items. Note 5 contains additional information on assets and liabilities recorded at fair value in the Condensed Consolidated Financial Statements.

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Investments – The Company’s equity securities are recorded at fair value with changes in fair value included within the statement of operations. Equity securities without a readily determinable market value are carried at cost less impairment, adjusted for observable price changes in orderly transactions for an identical or similar investment of the same issuer. The Company considers certain debt instruments as available-for-sale securities, 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 Condensed Consolidated Statements of Operations and Comprehensive Loss.

Stock Based Compensation – The Company’s 2021 Omnibus Incentive Plan allows for various types of equity-based incentive awards. Stock based compensation expense is based on awards that are expected to vest over the requisite service periods and are based on the fair value of the award measured on the grant date. Vesting requirements vary for directors, officers, and employees. In general, time-based awards fully vest after one year for directors and vest in equal annual installments over a three-year period for officers and employees. Performance-based awards vest upon achievement of certain milestones. Forfeitures are accounted for when they occur.

Severance charges - From time to time, the Company evaluates its resources and optimizes its business plan to align to changing needs of executing on its strategy. These actions may result in voluntary or involuntary employee termination benefits. Voluntary termination benefits are accrued when an employee accepts the related offer. Involuntary termination benefits are accrued upon the commitment to a termination plan and the benefit arrangement is communicated to affected employees, or when liabilities are determined to be probable and estimable, depending on the existence of a substantive plan for severance or termination. The following table summarizes the change in accrued liabilities, presented within Other current liabilities and Other long-term liabilities Condensed Consolidated Balance Sheets:


Balance at December 31, 2021	$	238
Accruals		692
Cash payments		(167)
Balance at September 30, 2022	$	763


	September 30,		December 31,
	2022		2021
Current	$	397	$	217
Noncurrent	$	366	$	21

In addition, during the three and nine months ended September 30, 2022, the Company recorded $1,237 of accelerated equity compensation expense in connection with the vesting of an employee’s outstanding equity awards as part of the termination severance agreement. Amounts are recorded as Selling, general and administrative in the Condensed Consolidated Statements of Operations and Comprehensive Loss.

Income Taxes - For interim income tax reporting, due to a full valuation allowance on net deferred tax assets, no income tax expense or benefit is recorded unless it is an unusual or infrequently occurring item. The tax effects of unusual or infrequently occurring items, including changes in judgment about valuation allowances and effects of changes in tax laws or rates, are reported in the interim period in which they occur. See Note 2 for income tax considerations as a result of the acquisition of GVB.

Segments - As a result of the acquisition of GVB (see Note 2) and ongoing evaluation of the Company’s strategy across our plant science and intellectual property platform (tobacco, hemp/cannabis, and hops), the Company is reevaluating its operating and reporting segments, which is expected to be finalized by the end of fiscal 2022 once the corporate and management reporting structure realignment is completed. As September 30, 2022, the Company continues to operate its business in one single operating and reportable segment. The Company’s chief operating decision maker assesses, measures, and reviews the operating and financial results at the consolidated level for the entire platform.

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Recent Accounting Pronouncements – In June 2016, the FASB issued ASU 2016-13, “Measurement of Credit Losses on Financial Instruments.” The standard replaces the incurred loss model with the current expected credit loss (CECL) model to estimate credit losses for financial assets measured at amortized cost and certain off-balance sheet credit exposures. The CECL model requires companies to estimate credit losses expected over the life of the financial assets based on historical experience, current conditions and reasonable and supportable forecasts. The provisions of the ASU have an effective date for the Company beginning after December 15, 2022 and interim periods within those fiscal years. The Company does not expect the new credit loss standard to have a material impact to the Condensed Consolidated Financial Statements.

We consider the applicability and impact of all ASUs. If the ASU is not listed above, it was determined that the ASU was either not applicable or would have an immaterial impact on our financial statements and related disclosures.

NOTE 2. – BUSINESS ACQUISITIONS

On May 13, 2022, the Company entered into and closed the transactions contemplated by the Reorganization and Acquisition Agreement (the “Reorganization Agreement”) with GVB Biopharma (“GVB”). Under the terms of the Reorganization Agreement, the Company acquired substantially all of the assets of GVB’s business dedicated to hemp-based cannabinoid extraction, refinement, contract manufacturing and product development (the “Transaction”). The acquisition of GVB allows the Company to leverage its expertise in receptor and plant science to develop its hemp/cannabis franchise and add significant scale in the immediate term. GVB is included in the Company’s consolidated single operating and reportable segment.

The aggregate consideration for the Transaction consisted of (i) the assumption of approximately $4,637 of debt, (ii) the assumption and direct payment of certain third-party transaction costs incurred by GVB in connection with the Transaction totaling approximately $1,753 and (iii) the issuance to GVB of 32,900,000 unregistered shares of common stock of the Company (the “Shares”) with a fair value of $51,653. The fair value of the Company’s common stock issued as part of the consideration was determined based upon the opening stock price of the Company’s shares as of the acquisition date. The Shares are subject to a lock-up and restrictions on transfer for at least six months following closing and thereafter, one-third of the Shares will be released from the lock-up after six months, one-third will be released from the lock-up after nine months and the remainder will be released after one year. Certain Shares held by former preferred holders of GVB stock have limited registration rights associated with approximately 8,959,533 total Shares.

The Transaction was structured as a tax-free re-organization pursuant to Internal Revenue Code Section 368(a)(1)(c). Accordingly, the tax basis of net assets acquired will retain their carry over tax basis and holding period in purchase accounting.

The Company has provisionally estimated fair values for the assets purchased, liabilities assumed and purchase consideration as of the date of the acquisition. The determination of estimated fair value required management to make significant estimates and assumptions based on information that was available at the time the Condensed Consolidated Financial Statements were prepared.

During the third quarter of 2022, the preliminary fair values of the assets acquired and liabilities assumed as of May 13, 2022 were adjusted to reflect the ongoing acquisition valuation analysis procedures of property and equipment, intangible assets, deferred taxes, and working capital adjustments. These adjustments resulted in a combined reduction to goodwill of $10,452.

The amounts reported are considered provisional as the Company is finalizing the valuations that are required to allocate the purchase price through the measurement period, which remains open as of September 30, 2022. As a result, the allocation of the provisional purchase price may change in the future, which could be material.

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The following table presents management’s purchase price allocation:


Cash	$	456
Accounts receivable		2,944
Inventory		5,292
Other assets		519
Property, plant & equipment		11,388
Operating leases right-of-use assets, net		1,231
Goodwill		33,748
Tradename		4,600
Customer relationships		5,800
Accounts payable and accrued expenses		(2,958)
Other current liabilities		(944)
Lease liabilities		(1,259)
Auto loans		(387)
Deferred tax liability		(2,774)
Bridge loan		(4,250)
Fair value of net assets acquired	$	53,406

The fair values of the assets acquired were determined using one of three valuation approaches: market, income or cost. The selection of a particular method for a given asset depended on the reliability of available data and the nature of the asset, among other considerations.

The market approach estimates the value for a subject asset based on available market pricing for comparable assets. The income approach estimates the value for a subject asset based on the present value of cash flows projected to be generated by the asset. The projected cash flows were discounted at a required rate of return that reflects the relative risk of the asset and the time value of money. The projected cash flows for each asset considered multiple factors from the perspective of a marketplace participant including revenue projections from existing customers, attrition trends, tradename life-cycle assumptions, marginal tax rates and expected profit margins giving consideration to historical and expected margins. The cost approach estimates the value for a subject asset based on the cost to replace the asset and reflects the estimated reproduction or replacement cost for the asset, less an allowance for loss in value due to depreciation or obsolescence, with specific consideration given to economic obsolescence if indicated. These fair value measurement approaches are based on significant unobservable inputs, including management estimates and assumptions.

Current Assets and Liabilities

The fair value of current assets and liabilities, excluding inventory, was assumed to approximate their carrying value as of the acquisition date due to the short-term nature of these assets and liabilities.

The fair value of in-process and finished goods inventory acquired was estimated by applying a version of the income approach called the comparable sales method. This approach estimates the fair value of the assets by calculating the potential revenue generated from selling the inventory and subtracting from it the costs related to the completion and sale of that inventory and a reasonable profit allowance for these remaining efforts. Based upon this methodology, the Company recorded the inventory acquired at fair value resulting in an increase in inventory of $978, which was fully amortized in the three month period ended June 30, 2022 in the Condensed Consolidated Statement of Operations and Comprehensive Loss.

Property, Plant and Equipment

The fair value of PP&E acquired was estimated by applying the cost approach for personal property and leasehold improvements. The cost approach was applied by developing a replacement cost and adjusting for economic depreciation and obsolescence.

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Leases

The Company recognized operating lease liabilities and operating lease right-of-use assets for office and manufacturing facilities in (i) Las Vegas, Nevada (ii) Grass Valley, Oregon (iii) Prineville, Oregon, and (iv) Tygh Valley, Oregon, accordance with ASC 842, Leases.

The following table summarizes the Company’s discount rate and remaining lease terms as of the acquisition date:


Weighted average remaining lease term in years	3.8
Weighted average discount rate	8.3	%

The Company concluded there were no off-market lease intangibles on the date of acquisition based on an evaluation of market rents per square foot, geographic location and nature of use of the underlying asset, among other considerations.

Intangible assets

The purchase price was allocated to intangible assets as follows:


			Weighted Average
	Fair Value		Amortization Period		Weighted Average
Definite-lived Intangible Assets	Assigned		(Years)		Discount Rate
Customer relationships	$	5,800		10		23.50%
Tradename	$	4,600		Indefinite		23.50%

Customer Relationships

Customer relationships represent the estimated fair value of contractual and non-contractual customer relationships GVB had as of the acquisition date. These relationships were valued separately from goodwill at the amount that an independent third party would be willing to pay for these relationships. The fair value of customer relationships was determined using the multi-period excess-earnings method, a form of the income approach. The estimated useful life of the existing customer base was based upon the historical customer annual attrition rate of 20%, as well as management’s understanding of the industry and product life cycles.

Tradename

Tradename represents the estimated fair value of GVB’s corporate and product names. The acquired tradename was valued separately from goodwill at the amount that an independent third party would be willing to pay for use of these names. The fair value of the tradename was determined by utilizing the relief from royalty method, a form of the income approach, with a royalty rate of 1.0%. The GVB tradename was assumed to have an indefinite useful life based upon long-term management expectations and future operating plans.

Deferred Taxes

The Company determined the deferred tax position to be recorded at the time of the GVB acquisition in accordance with ASC Topic 740, Income Taxes, resulting in recognition of deferred tax liabilities for future reversing of taxable temporary differences primarily for intangible assets and property, plant and equipment. This resulted in a preliminary net deferred tax liability of $2,774, which includes the carryover basis of historical recognized deferred tax assets, liabilities and valuation allowance.

The net deferred tax liabilities recorded as a result of the acquisition of GVB was determined by the Company to also provide future taxable temporary differences that allow for the Company to utilize certain previously fully reserved deferred tax assets. Accordingly, the Company recognized a reduction to its valuation allowance in the three and nine months ended September 30, 2022, resulting in a net tax benefit of approximately $2,581 for the period.

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Goodwill

The excess of the purchase price over the fair value of net tangible and intangible assets acquired and liabilities assumed was allocated to goodwill. A variety of factors contributed to the goodwill recognized, including the value of GVB’s assembled work force, the incremental value resulting from GVB’s capabilities in hemp/cannabis, operational synergies across the plant science platform, and the expected revenue growth over time that is attributable to increased market share from future products and customers. Goodwill recorded in the transaction will be non-deductible.

Actual and Pro Forma (unaudited) disclosures

The results of operations and assets from the GVB acquisition have been included in the Company’s Condensed Consolidated financial statements since the acquisition date. For the three and nine months ended September 30, 2022, net revenues related to GVB were $7,848 and $12,354 respectively, and net loss was $2,743 and $4,217 respectively.

The following unaudited pro forma information presents the consolidated results of operations of the Company and assumes the acquisition occurred on January 1, 2021:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2022		2021		2022		2021

	(in thousands, except for per-share data)
Revenue, net	$	19,450	$	14,141	$	53,630	$	43,650
Net loss	$	(12,836)	$	(8,587)	$	(33,438)	$	(20,700)
Net loss per common share - basic and diluted	$	(0.06)	$	(0.04)	$	(0.17)	$	(0.11)
Weighted average common shares outstanding - basic and diluted		210,131		195,621		201,297		186,898

The unaudited pro forma results are presented for illustrative purposes only and do not reflect the realization of potential cost savings, and any related integration costs. Certain costs savings may result from the acquisition; however, there can be no assurance that these cost savings will be achieved. These unaudited pro forma results do not purport to be indicative of the results that would have been obtained, or to be a projection of results that may be obtained in the future. These unaudited pro forma results include certain adjustments, primarily due to amortization expense due to the fair value adjustment of inventory, acquisition related costs and the impact of income taxes on the pro forma adjustments.

Acquisition costs

During the nine months ended September 30, 2022, direct costs incurred as a result of the acquisition of $839 were expensed as incurred and included in Sales, General and Administrative in the Condensed Consolidated Statements of Operations and Comprehensive Loss.

NOTE 3. - INVENTORY

Inventories at September 30, 2022 and December 31, 2021 consisted of the following:


	September 30,		December 31,
	2022		2021
Raw materials	$	7,619	$	2,634
Work in process		1,863		—
Finished goods		2,782		247
	$	12,264	$	2,881

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NOTE 4. – INVESTMENTS & OTHER ASSETS

The total carrying value of the Company’s investments and other assets at September 30, 2022 and December 31, 2021 consisted of the following:


	September 30,		December 31,
	2022		2021
Panacea Life Sciences Holdings, Inc. common stock	$	299	$	2,340
Aurora stock warrants		—		5
Change Agronomy Ltd. ordinary shares		682		—
Total investments	$	981	$	2,345

Investment in Panacea Life Sciences Holdings, Inc.

On December 3, 2019, the Company entered into a securities purchase agreement with Panacea Life Sciences, Inc. (“Panacea”) whereby the Company acquired shares of Panacea Series B preferred stock; a convertible note receivable with a $7,000 face value; and a warrant to purchase additional shares of Series B preferred stock.

On June 30, 2021, the Company entered into a Promissory Note Exchange Agreement with Panacea and a Securities Exchange Agreement with Panacea, Exactus, Inc. (“Exactus”) and certain other Panacea shareholders. Pursuant to the Securities Exchange Agreement, Exactus fully acquired Panacea. These transactions effected the (i) conversion of all of the Company’s Series B Preferred Stock in Panacea into 91,016,026 shares of common stock in Exactus valued at $9,102 as of June 30, 2021 and (ii) the conversion of the Company’s existing debt in Panacea by converting the outstanding $7,000 principal balance convertible note receivable and all accrued but unpaid interest thereon for fee simple ownership of Needle Rock Farms (224 acres in Delta County, Colorado) and equipment valued at $2,248, $500 in Panacea’s Series B Preferred Stock (which was subsequently converted to Exactus common stock under the Securities Exchange Agreement; this balance is reflected in final shares as stated above), and a new $4,300 promissory note (the “Promissory note receivable”) with a maturity date of June 30, 2026 and a 0% interest rate. The Promissory note receivable is with a related party of Panacea and is fully secured by a first priority lien on Panacea’s headquarters located in Golden, Colorado. All other rights and obligations of the Company in Panacea and Panacea’s affiliate, Quintel-MC Incorporated, were terminated by this transaction—including all warrant rights and obligations for future investment. The conversion was recorded as a non-monetary transaction, based on the fair value of the assets received, and resulted in a gain of $2,548 which was included within the Condensed Consolidated Statements of Operations and Comprehensive Loss as “Gain on Panacea investment conversion” during 2021.

The Promissory note receivable was issued at a value of $3,684 ($4,300 face value less $616 discount) and is included within Other assets on the Condensed Consolidated Balance Sheets. As of September 30, 2022 and December 31, 2021, the Promissory note receivable balance was $3,829 and $3,741, respectively. The Company intends to hold the Promissory note receivable to maturity and the associated discount will be amortized into interest income over the term of the note. The ownership of Needle Rock Farms and related equipment is included within Property, plant, and equipment, net on the Condensed Consolidated Balance Sheets. The common shares of Exactus, Inc. are considered equity securities in accordance with ASC 321 and are recorded at fair value—changes in fair value will be included within the statement of operations and comprehensive loss. See Note 5 for additional information on the fair value measurements.

On October 25, 2021, Exactus announced the completion of a 1 for 28 reverse stock split as well as an entity name change to Panacea Life Sciences Holdings, Inc. (OTCQB: PLSH). As a result of the reverse stock split, our 91,016,026 shares were adjusted to 3,250,573 shares.

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Investment in Change Agronomy Ltd.

On December 10, 2021, the Company entered into a subscription agreement to invest £500 (pounds sterling, in thousands), in exchange for 592,888 ordinary shares of Change Agronomy Ltd. (“CAL”), a private company existing under the laws of England, at a price per share of £0.84333. CAL is a vertically integrated sustainable industrial hemp business that combines genetics with leading agronomic techniques and infrastructure to provide full-service industrial hemp products to multiple global end markets. CAL presently has operations in Manitoba, Canada, and Italy. This equity investment was part of an Offer for Subscription by CAL for a minimum total of £3,000 at the same price per ordinary share. Approximately U.S. $682 in funds were wired to CAL on January 26, 2022, and our investment equated to approximately 1.8% of CAL’s total equity.

In accordance with ASU 2019-04, a foreign currency-denominated equity investments that are measured using the measurement alternative are nonmonetary items that should be remeasured using their historical exchange rates. Accordingly, for the three and nine-month periods ended September 30, 2022, there is no foreign currency exchange gain or loss recorded in the Condensed Consolidated Statement of Operations and Comprehensive Loss related to the investment in Change Agronomy Ltd.

During the three and nine months ended September 30, 2022 and 2021, respectively, there were no impairment triggering events identified for investments.

NOTE 5. – FAIR VALUE MEASUREMENTS AND SHORT-TERM INVESTMENTS

Assets and Liabilities Measured at Fair Value on a Recurring Basis

Fair value measurement standards apply to certain financial assets and liabilities that are measured at fair value on a recurring basis (each reporting period). For the Company, these financial assets and liabilities include its short-term investment securities and equity investments. The Company does not have any nonfinancial assets or liabilities that are measured at fair value on a recurring basis.

The following table presents information about our assets and liabilities measured at fair value as of September 30, 2022 and December 31, 2021, and indicates the fair value hierarchy of the valuation techniques the Company utilized to determine such fair value:


	Fair Value
	September 30, 2022
	Level 1		Level 2		Level 3		Total
Assets
Short-term investment securities:
Money market funds	$	4,497	$	—	$	—	$	4,497
Corporate bonds		—		19,924		—		19,924
U.S. treasury securities		—		16,936		—		16,936
Total short-term investment securities	$	4,497	$	36,860	$	—	$	41,357
Investments:
Panacea Life Sciences Holdings, Inc. common shares	$	299	$	—	$	—	$	299
Change Agronomy Ltd. ordinary shares		—		—		682		682
Total investments	$	299	$	—	$	682	$	981

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	Fair Value
	December 31, 2021
	Level 1		Level 2		Level 3		Total
Assets
Short-term investment securities:
Money market funds	$	8,919	$	—	$	—	$	8,919
Corporate bonds		—		38,481		—		38,481
Total short-term investment securities	$	8,919	$	38,481	$	—	$	47,400
Investments:
Panacea Life Sciences Holdings, Inc. common shares	$	2,340	$	—	$	—	$	2,340
Aurora stock warrants		—		—		5		5
Total investments	$	2,340	$	—	$	5	$	2,345

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. The Company classifies its money market funds within Level 1 because it uses quoted market prices to determine their fair value. The Company classifies its commercial paper, corporate notes, certificates of deposit, and U.S. government bonds within Level 2 because it uses quoted prices for similar assets or liabilities in active markets and each has a specified term and all level 2 inputs are observable for substantially the full term of each instrument.

Corporate bonds are valued using pricing models maximizing the use of observable inputs for similar securities.

The investment in Panacea Life Sciences Holdings Inc. common shares is considered an equity security with a readily determinable fair value. The fair value is determined using the quotable market price as of the last trading day of the fiscal quarter.

The investment in Change Agronomy Ltd. is in a privately held company and its stock does not have a readily determinable fair value; therefore, the investment is carried at cost less impairment, adjusted for observable price changes in orderly transactions for an identical or similar investment of the same issuer.

The following table sets forth a summary of the changes in fair value of the Company’s Level 3 investments for the nine months ended September 30, 2022:


Fair Value at December 31, 2021	$	5
Unrealized loss on Aurora stock warrants		(5)
Investment in Change Agronomy Ltd. ordinary shares		682
Fair

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