NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 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 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, 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 in the amount of $0 and $3,000,000 at September 30, 2018
and December 31, 2017, respectively. Cash and cash equivalents are stated at cost, which approximates fair value.
Short-term investment securities
-
The
Company’s short-term investment securities are classified as available-for-sale securities and consist of money
market funds, corporate bonds, U.S. government agency bonds, U.S. treasury securities, and commercial paper with maturities
greater than three months at the time of acquisition. The Company’s short-term investment securities are carried at
fair value within current assets on the Company’s Consolidated Balance Sheets, 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 Income (Loss).
Realized gains and losses on short-term investment securities are recorded in the other income (expense) portion of the
Company’s Consolidated Statements of Operations and Comprehensive Income (Loss). Interest earned, net of investment
fees, on the short-term investment securities are included in interest income.
Accounts receivable
-
The
Company periodically reviews aged account balances for collectability. The Company established an allowance for doubtful accounts
of $0 at both September 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 September 30, 2018 and December 31, 2017 consisted of the following:
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2018
|
|
|
2017
|
|
Inventory - tobacco leaf
|
|
$
|
1,714,923
|
|
|
$
|
1,552,474
|
|
Inventory - finished goods
|
|
|
|
|
|
|
|
|
Cigarettes and filtered cigars
|
|
|
237,995
|
|
|
|
289,004
|
|
Inventory - raw materials
|
|
|
|
|
|
|
|
|
Cigarette and filtered cigar components
|
|
|
1,537,349
|
|
|
|
1,636,059
|
|
|
|
|
3,490,267
|
|
|
|
3,477,537
|
|
Less: inventory reserve
|
|
|
160,000
|
|
|
|
195,000
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
3,330,267
|
|
|
$
|
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 September 30, 2018 and December 31, 2017 consisted of the following:
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2018
|
|
|
2017
|
|
Intangible assets, net
|
|
|
|
|
|
|
|
|
Patent and trademark costs
|
|
$
|
6,984,452
|
|
|
$
|
6,327,467
|
|
Less: accumulated amortization
|
|
|
2,985,729
|
|
|
|
2,517,465
|
|
Patent and trademark costs, net
|
|
|
3,998,723
|
|
|
|
3,810,002
|
|
|
|
|
|
|
|
|
|
|
License fees, net (see Note 10)
|
|
|
2,625,226
|
|
|
|
1,450,000
|
|
Less: accumulated amortization
|
|
|
415,976
|
|
|
|
326,591
|
|
License fees, net
|
|
|
2,209,250
|
|
|
|
1,123,409
|
|
|
|
|
|
|
|
|
|
|
MSA signatory costs
|
|
|
2,202,000
|
|
|
|
2,202,000
|
|
|
|
|
|
|
|
|
|
|
License fee for predicate cigarette brand
|
|
|
300,000
|
|
|
|
300,000
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
8,709,973
|
|
|
$
|
7,435,411
|
|
Amortization expense relating to the above
intangible assets for the three and nine months ended September 30, 2018 amounted to $219,171 and $557,648, respectively ($145,934
and $429,832 for the three and nine months ended September 30, 2017, respectively).
The estimated annual average amortization
expense for the next five years is approximately $434,000 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
nine months ended September 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 September 30, 2018 and December 31, 2017.
The Company’s federal and state tax
returns for the years ended December 31, 2015 through December 31, 2017 are currently open to audit under the statutes of limitations.
There were no pending audits as of September 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 September 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 September 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 nine months ended September 30, 2018, net sales revenue from products transferred over time amounted to approximately
$3,987,000 and $12,479,000, respectively, and net sales revenue from products transferred at a point in time amounted to approximately
$2,273,000 and $6,812,000, 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 Income (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 $7,000 and $23,000 for the three and nine months
ended September 30, 2018, respectively ($6,000 and $49,000 for the three and nine months ended September 30, 2017, respectively).
Income (Loss) Per Common Share -
Basic income (loss) per common share is computed using the weighted-average number of common shares outstanding. Diluted
income (loss) per share is computed assuming conversion of all potentially dilutive securities. Potential common shares outstanding
are excluded from the computation if their effect is anti-dilutive.
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, investments (stock warrants), accounts payable, accrued expenses and warrant liability. Other than for cash equivalents,
short-term investment securities, investments (stock warrants), and warrant liability, fair value is assumed to approximate carrying
values for these financial instruments, since they are short term in nature, they are receivable or payable on demand, or had stated
interest rates that approximate the interest rates available to the Company as of the reporting date. The determination of the
fair value of cash equivalents, short-term investment securities, investments (stock warrants), and warrant liability are discussed
in Note 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.
The Company has an investment in stock warrants
that are considered equity securities. The Company’s investment in stock warrants are recorded at fair value with changes
in fair value recorded in net income (loss).
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 has been evaluating its current lease contracts
and will likely record a right-to-use asset and a corresponding lease liability, primarily relating to real estate leases, during
the first quarter of 2019, but the Company believes the impact of the ASU on its consolidated financial statements will be not
be material.
NOTE 2. – OCTOBER 2017 REGISTERED DIRECT OFFERING
On October 10, 2017, the Company closed
a registered direct offering with institutional investors purchasing an aggregate of 20,570,000 shares of the Company’s common
stock at a price of $2.6250 per share generating net cash proceeds for the Company of $50,732,200, after deducting expenses associated
with the transaction.
NOTE 3. – JUNE 2017 WARRANT EXERCISE AGREEMENTS
On June 19, 2017, the Company entered into
Warrant Exercise Agreements (the “Agreements”) with all the holders (the “Holders”) of outstanding warrants
to purchase up to 7,043,211 shares of common stock of the Company at $1.00 per share and warrants to purchase up to 4,250,000
shares of common stock of the Company at $1.45 per share (collectively, the “Warrants”). These Warrants to purchase
shares of the Company’s common stock were acquired by the Holders in registered direct offerings in October of 2016 and
in July of 2016, respectively. The Company and the Holders agreed that the Holders would, subject to beneficial ownership limitations
on exercise contained in the Warrants, exercise all the Warrants for cash. During the second and third quarters of 2017, the Holders
exercised 7,043,211 Warrants at $1.00 per share and 4,250,000 Warrants at $1.45 per share, resulting in net proceeds to the Company
in the amount of $12,336,858, after deducting expenses associated with the transaction.
In consideration for the Holders exercising
their Warrants for cash, the Company issued to each Holder a new warrant (the “New Warrants”) to purchase shares of
common stock of the Company equal to the number of shares of common stock received by each Holder upon the cash exercise of the
Holder’s Warrants. The terms of the New Warrants are substantially similar to the terms of the Warrants exercised, except
the New Warrants (i) have an exercise price equal to $2.15 per share and (ii) are exercisable six months from the date of issuance
of the New Warrants for a period of five (5) years. Accordingly, the Company issued an aggregate of 11,293,211 New Warrants to
the Holders, upon exercise of the Holder’s Warrants as described above. The New Warrants had a fair value of $16,049,031
at issuance and have been recorded as an adjustment to capital in excess of par value.
NOTE 4. - MANUFACTURING FACILITY
The Company’s manufacturing operations
at its North Carolina factory continued to utilize additional production capacity due to increased production and sales of the
contract manufacturing of filtered cigars and cigarettes during the three months ended September 30, 2018. This improvement resulted
in gross profit on sales of products in the amount of $150,949 and $384,241 for the three and nine months ended September 30, 2018,
respectively, as compared to a gross loss on sales of products in the amount of $340,369 and $779,321 for the three and nine months
ended September 30, 2017, respectively. Raw material component costs, direct manufacturing costs, and an overhead allocation are
included in the Cost of goods sold and Finished goods inventory. General and administrative expenses of the factory amounted to
$311,918 and $941,357 for the three and nine months ended September 30, 2018, respectively ($300,824 and $635,514 for the three
and nine months ended September 30, 2017, respectively).
NOTE 5. - MACHINERY AND EQUIPMENT
Machinery and equipment at September 30,
2018 and December 31, 2017 consisted of the following:
|
|
Useful Life
|
|
September 30,
2018
|
|
|
December 31,
2017
|
|
Cigarette manufacturing equipment
|
|
3 - 10 years
|
|
$
|
4,537,696
|
|
|
$
|
4,302,299
|
|
Office furniture, fixtures and equipment
|
|
5 years
|
|
|
135,909
|
|
|
|
110,499
|
|
Laboratory equipment
|
|
5 years
|
|
|
93,109
|
|
|
|
32,193
|
|
Leasehold improvements
|
|
6 years
|
|
|
163,359
|
|
|
|
106,429
|
|
|
|
|
|
|
4,930,073
|
|
|
|
4,551,420
|
|
Less: accumulated depreciation
|
|
|
|
|
1,623,472
|
|
|
|
1,235,373
|
|
Machinery and equipment, net
|
|
|
|
$
|
3,306,601
|
|
|
$
|
3,316,047
|
|
Depreciation expense was $132,846 and $388,668
for the three and nine months ended September 30, 2018, respectively ($88,711 and $265,296 for the three and nine months ended
September 30, 2017, respectively).
NOTE 6. - INVESTMENT
The Company (through its wholly-owned subsidiary,
Botanical Genetics) held a 14.8% equity investment in Anandia Laboratories, Inc., a Canadian plant biotechnology company (“Anandia”).
On August 8, 2018, all of Anandia’s outstanding common stock was acquired by Aurora Cannabis, Inc. (“Aurora”),
a Canadian company (TSX: ACB.TO), in exchange for (i) free trading shares of Aurora common stock, and (ii) warrants with a five-year
term to purchase one-half of a share of Aurora common stock for each whole share of Aurora common stock received as part of the
transaction. As a result of the transaction, the Company received 1,947,943 shares of Aurora common stock and warrants to
purchase 973,971 shares of Aurora common stock that had a fair value of $9,221,594 and $2,807,958, respectively. The Company recorded
a realized gain on the transaction in the amount of $4,515,971 during the three months ended September 30, 2018. Subsequent to
the transaction, the Company sold all of its Aurora common stock resulting in net sales proceeds to the Company of $13,051,503
and realized a gain on the sale of $3,829,909. The aggregate realized gains from the Anandia transaction and the sale of the Aurora
common shares amount to $8,345,880 for the three and nine months ended September 30, 2018. As a result of the sale of the Aurora
stock, the Company expects to utilize Federal and State net operating losses to minimize or eliminate the current income tax effect
of the realized gain. Accordingly, the Company anticipates a corresponding reduction to the deferred tax assets and the associated
valuation allowance recorded on the net operating losses.
The warrants to purchase 973,971 shares
of Aurora common stock have a five-year contractual term, an exercise price of $9.37 per share (Canadian Dollars; approximately
$7.26 per share U.S. Dollars at September 30, 2018), are currently exercisable, are considered an equity security, and are recorded
at fair value. The Company recorded the fair value of the Aurora common stock warrants of $6,731,114 at September 30, 2018, using
the Black-Scholes pricing model, and recorded an unrealized gain on the warrants in the amount of $3,923,156 for the three months
ended September 30, 2018. The fair value of the warrants at September 30, 2018 in the amount of $6,731,114 was classified within
Other assets on the Company’s Consolidated Balance Sheets.
Effective January 1, 2018, the Company adopted
Financial Accounting Standards Board ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement
of Financial Assets and Financial Liabilities. This guidance changes how entities account for equity investments that do not result
in consolidation and are not accounted for under the equity method of accounting. Under ASU 2016-01, the Company is required to
measure its investment in Anandia at fair value at the end of each reporting period and recognize changes in fair value in net
income. As allowed by ASU 2016-01, since the Company’s investment in Anandia did not have readily determinable fair value,
the Company elected to account for its investment at cost. The cost basis is required to be adjusted in the event of impairment,
if any, and for any observable price changes in orderly transactions for the identical or a similar investment of the same issuer.
Accordingly, and as a result of, a prior equity issuance by Anandia that was considered an orderly transaction, the Company recorded
an unrealized gain on its investment in Anandia in the amount of $6,147,088 during the three months ended March 31, 2018. There
were no further changes in the fair value of the Company’s equity investment in Anandia through the acquisition of Anandia
by Aurora on August 8, 2018, as discussed above. As a result of the fair value recording for both the Aurora common stock warrants,
discussed above, and the equity investment in Anandia, the Company recorded unrealized gains in the amount of $3,923,156 and $10,070,244
for the three and nine months ended September 30, 2018, respectively.
The Company’s investment in Anandia
was recorded using the equity method of accounting until the first quarter of 2017, when a dilutive event occurred bringing the
Company’s investment percentage in Anandia below 20%. Accordingly, the Company discontinued applying the equity method of
accounting for its investment in Anandia and began accounting for its investment in Anandia under the cost method of accounting.
The Company’s unrealized gain on the investment in Anandia was $346,180 for the nine months ended September 30, 2017. At
December 31, 2017, the Company’s investment balance in Anandia was $1,366,493, and was classified within Other assets on
the accompanying Consolidated Balance Sheets.
NOTE 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 September 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 September 30, 2018
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term investment securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money market funds
|
|
$
|
17,024,020
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
17,024,020
|
|
Corporate bonds
|
|
|
-
|
|
|
|
30,348,270
|
|
|
|
-
|
|
|
|
30,348,270
|
|
Commercial paper
|
|
|
-
|
|
|
|
1,198,890
|
|
|
|
-
|
|
|
|
1,198,890
|
|
U.S. treasury securities
|
|
|
-
|
|
|
|
4,001,605
|
|
|
|
-
|
|
|
|
4,001,605
|
|
U.S. government agency bonds
|
|
|
-
|
|
|
|
8,789,328
|
|
|
|
-
|
|
|
|
8,789,328
|
|
Total cash equivalents and short-term investment securities
|
|
$
|
17,024,020
|
|
|
$
|
44,338,093
|
|
|
$
|
-
|
|
|
$
|
61,362,113
|
|
Investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock warrants
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
6,731,114
|
|
|
$
|
6,731,114
|
|
|
|
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 investment in stock warrants are measured at fair value using the Black-Scholes pricing model and
are classified within Level 3 of the valuation hierarchy. The unobservable input used in the Black-Scholes pricing model is the
volatility factor and an estimated volatility factor of 85% was used at September 30, 2018. A 20% increase or decrease in the volatility
factor used at September 30, 2018 would have the impact of increasing or decreasing the fair value measurement of the stock warrants
by approximately $710,000.
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. A significant increases or decreases in the volatility input would result in a significantly higher or lower
fair value measurement. The Company’s outstanding warrants at September 30, 2018 do not include anti-dilution features and
therefore are not considered derivative instruments, and accordingly, do not have an associated warrant liability
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 and the accretion of interest during
the third quarter of 2018 in the amount of $4,431, the balance remaining as of September 30, 2018 amounted to $679,657, with $392,686
and $286,971 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 amounted
to $1,175,226 and is included in Intangible assets, net on the Company’s Consolidated Balance Sheets, and will be amortized
on a straight-line basis over the last-to-expire patent, which is expected to be in 2036.
NOTE 9. - WARRANTS FOR COMMON STOCK
At September 30, 2018, the Company had outstanding
warrants to purchase 11,293,211 shares of common stock of the Company with an exercise price of $2.15 per share and an expiration
date of December 20, 2022.
During the three and nine months ended September
30, 2018, warrant holders exercised 94,721 and 794,869 warrants, respectively, on a cashless basis, resulting in the issuance of
63,832 and 490,012 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.
The Company estimates the value of warrant
liability upon issuance of warrants that are considered derivative instruments and at each balance sheet date using the binomial
lattice model to allocate total enterprise value to the warrants and other securities in the Company’s capital structure.
Volatility was estimated based on historical observed equity volatilities and implied (forward) or expected volatilities for a
sample group of guideline companies and consideration of recent market trends. The Company’s outstanding warrants at September
30, 2018 do not include anti-dilution features and therefore are not considered derivative instruments, and accordingly, do not
have an associated warrant liability.
The following table is a roll-forward summary
of the warrant liability since December 31, 2016:
Fair value at December 31, 2016
|
|
$
|
58,681
|
|
Loss as a result of change in fair value
|
|
|
157,809
|
|
Fair value at December 31, 2017
|
|
|
216,490
|
|
Gain as a result of change in fair value
|
|
|
(48,711
|
)
|
Reclassification of warrant liability to capital in excess of par
|
|
|
(167,779
|
)
|
Fair value at September 30, 2018
|
|
$
|
-
|
|
The aggregate net gain as a result of the
Company’s warrant liability for the three and nine months ended September 30, 2018 amounted to $0 and $48,711, respectively
(the aggregate net loss for the three and nine months ended September 30, 2017 amounted to $55,886 and $138,813, respectively),
which are included in Other income (expense) under Warrant liability gain (loss), net in the accompanying Consolidated Statements
of Operations and Comprehensive Income (Loss).
The following table summarizes
the Company’s warrant activity since December 31, 2016:
|
|
Number of
Warrants
|
|
Warrants outstanding at December 31, 2016
|
|
|
13,781,921
|
|
Warrants exercised during 2017
|
|
|
(1,470,027
|
)
|
Warrants expired during 2017
|
|
|
(223,814
|
)
|
Warrants issued pursuant to June 2017 warrant exercise agreements
|
|
|
11,293,211
|
|
Warrants exercised pursuant to June 2017 warrant exercise agreements
|
|
|
(11,293,211
|
)
|
Warrants outstanding at December 31, 2017
|
|
|
12,088,080
|
|
Warrants exercised during 2018
|
|
|
(794,869
|
)
|
Warrants outstanding at September 30, 2018
|
|
|
11,293,211
|
|
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 Income (Loss). The amounts expensed during
the three and nine months ended September 30, 2018 were $86,589 and $307,659, respectively ($56,250 and $175,890 for the three
and nine months ended September 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 nine months ended September 30, 2018, the aggregate
costs incurred related to capitalized patent costs and patent maintenance expense amounted to $38,394 and $72,502, respectively
($11,022 and $42,730 for the three and nine months ended September 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 nine months ended September 30, 2018, the aggregate costs incurred related to capitalized patent costs and patent maintenance
expense amounted to $81,505 and $81,584, respectively ($236 and $30,102 for the three and nine months ended September 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. The amounts expensed during the three and nine
months ended September 30, 2018 were $30,339 and $50,565.
Other 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 $40,374
and $89,385 for the three and nine months ended September 30, 2018, respectively ($24,506 and $73,516 for the three and nine months
ended September 30, 2017), and was included in Amortization expense on the Company’s Consolidated Statements of Operations
and Comprehensive Income (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. Amortization of the license fee began in the third
quarter of 2018.
On August 22, 2014, the Company entered
into a Commercial License Agreement with Precision PlantSciences, Inc. (the “Precision License”). The Precision License
grants the Company a non-exclusive, but fully paid up right and license to use technology and materials owned by Precision PlantSciences
for a license fee of $1,250,000. The Precision License continues through the life of the last-to-expire patent, which is expected
to be in 2028.
On August 27, 2014, the Company entered
into an additional exclusive License Agreement (the “License Agreement”) with NCSU. Under the License Agreement, the
Company paid NCSU a non-refundable, non-creditable lump sum license fee of $125,000, and the Company must pay to NCSU an additional
non-refundable, non-creditable lump sum fee of $75,000 upon issuance of a U.S. utility patent included in the patent rights. A
patent was issued during the first quarter of 2017 under this clause, and accordingly, the $75,000 was due and payable to NCSU.
The $75,000 cost was included in Research and development costs on the Company’s Consolidated Statements of Operations and
Comprehensive Income (Loss) for the three months ended March 31, 2017 and the nine months ended September 30, 2017. Additionally,
under the License Agreement the Company paid NCSU a non-refundable, non-creditable license maintenance fee in the amount of $15,000
during the year ended December 31, 2017. The Company is obligated to pay to NCSU an annual minimum royalty fee of $20,000 in 2018,
$30,000 in 2019, and $50,000 per year thereafter for the remaining term of the License Agreement. The Company is also responsible
for reimbursing NCSU for actual third-party patent costs incurred. During the three and nine months ended September 30, 2018, the
aggregated costs incurred related to capitalized patent costs and patent maintenance expense amounted to $2,140 and $11,605, respectively
($12,928 and $37,170 for the three and nine months ended September 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 Income (Loss).
On September 28, 2015, the Company’s
wholly-owned subsidiary, Botanical Genetics, entered into a Sponsored Research Agreement (the “Agreement”) with Anandia
Laboratories Inc. (“Anandia”). Pursuant to the Agreement, Anandia conducted research on behalf of the Company relating
to the hemp/cannabis plant. During the three and nine months ended September 30, 2018, expenses related to the Agreement amounted
to $0 and $130,850, respectively ($196,275 and $457,975 for the three and nine months ended September 30, 2017, respectively).
Under the terms of the Agreement, the Company will have co-exclusive worldwide rights with Anandia to all the intellectual property
resulting from the sponsored research between the Company and Anandia. The party that commercializes such intellectual property
in the future will pay royalties in varying amounts to the other party, with the amount of such royalties being dependent upon
the type of products that are commercialized in the future. If either party sublicenses such intellectual property to a third-party,
then the Company and Anandia will share equally in such sublicensing consideration. As discussed in Note 6, Anandia was purchased
by Aurora Cannabis Inc. on August 8, 2018 and has become a wholly-owned subsidiary of Aurora Cannabis Inc. The Agreement is still
currently in effect and the Company is in discussions with Anandia regarding an amendment to the Agreement to conduct additional
research together.
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 nine months ended September 30, 2018, expenses related to the agreements amounted
to $116,265 and $296,443, respectively ($113,942 and $225,516 for the three and nine months ended September 30, 2017, respectively).
On May 1, 2018, the Company entered into
a University Growing and Evaluation Agreement (the “Agreement”) with the University of Kentucky Research Foundation
(“UKRF”) whereby UKRF will provide the Company with services relating to growing certain tobacco breeding lines of
the Company. Under the Agreement, the Company is obligated to pay $75,000 to UKRF in three installments of $25,000 each
through January 31, 2019. During the three and nine months ended September 30, 2018, expenses related to the Agreement amounted
to $25,000 and $50,000.
Lease Agreements
- The Company
leases a manufacturing facility and warehouse located in North Carolina on a triple net lease basis. The lease commenced on January
14, 2014 and had an initial term of twelve (12) months. The lease contains four (4) additional extensions; with one lease extension
being for an additional one (1) year and with the other three (3) lease extensions each being for an additional two (2) years in
duration, exercisable at the option of the Company. The Company is currently in the second two-year lease extension term that will
expire on October 31, 2019. The lease expense for the three and nine months ended September 30, 2018 amounted to approximately
$42,000 and $127,000, respectively (approximately $38,000 and $115,000 for the three and nine months ended September 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 -
|
|
$
|
42,000
|
|
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, expired on August 14, 2018, and contains twelve-month renewal options as long as the Company continues
to lease the warehouse. Future minimum lease payments will be approximately $56,000 per year for each subsequent year the warehouse
space is leased by the Company.
On October 4, 2017, the Company entered
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 $19,000, $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 $17,000 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 nine months ended September
30, 2018, the Company incurred expenses relating to these contracts in the approximate amount of $3,135,000 and $7,155,000, respectively.
There were no expenses incurred relating to the MRTP Application for the three and nine months ended September 30, 2017. Future
financial commitments under these contracts are estimated to amount to approximately an additional $4,000,000 and are expected
to be completed over the next three to six 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 been concluded.
On July 20, 2018, the SDNY Court granted the request by the Company to file a motion for partial summary judgment to substantially
limit the various damage claims by Crede, with the remaining schedule in the case being deferred until after the SDNY Court rules
on such motion.
The Company filed its partial summary judgment
motion on August 20, 2018, after which Crede filed its response on September 27, 2018, after which the Company filed its reply
to Crede’s response on October 11, 2018. The Company is now awaiting the decision by the SDNY Court on the Company’s
motion for partial summary judgment to substantially limit the various damage claims by Crede.
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. - INCOME (LOSS) PER COMMON SHARE
The following table sets forth the computation
of basic and diluted income (loss) per common share for the three-month periods ended September 30, 2018 and 2017, respectively:
|
|
September 30,
2018
|
|
|
September 30,
2017
|
|
|
|
|
|
|
|
|
Net income (loss) attributed to common shareholders
|
|
$
|
6,304,654
|
|
|
$
|
(3,316,634
|
)
|
|
|
|
|
|
|
|
|
|
Denominator for basic earnings (loss) per share-weighted average shares outstanding
|
|
|
124,376,061
|
|
|
|
100,673,834
|
|
|
|
|
|
|
|
|
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
Warrants and options outstanding
|
|
|
20,006,418
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Denominator for diluted earnings (loss) per common share-weighted average shares adjusted for dilutive securities
|
|
|
144,382,479
|
|
|
|
100,673,834
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) per common share - basic
|
|
$
|
0.05
|
|
|
$
|
(0.03
|
)
|
Net income (loss) per common share - diluted
|
|
$
|
0.04
|
|
|
$
|
(0.03
|
)
|
The following table sets forth the computation
of basic and diluted income (loss) per common share for the nine-month periods ended September 30, 2018 and 2017, respectively:
|
|
September 30,
2018
|
|
|
September 30,
2017
|
|
|
|
|
|
|
|
|
Net income (loss) attributed to common shareholders
|
|
$
|
952,490
|
|
|
$
|
(9,293,535
|
)
|
|
|
|
|
|
|
|
|
|
Denominator for basic earnings (loss) per share-weighted average shares outstanding
|
|
|
124,237,003
|
|
|
|
94,369,953
|
|
|
|
|
|
|
|
|
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
Warrants and options outstanding
|
|
|
20,006,418
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Denominator for diluted earnings (loss) per common share-weighted average shares adjusted for dilutive securities
|
|
|
144,243,421
|
|
|
|
94,369,953
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) per common share - basic
|
|
$
|
0.01
|
|
|
$
|
(0.10
|
)
|
Net income (loss) per common share - diluted
|
|
$
|
0.01
|
|
|
$
|
(0.10
|
)
|
Dilutive securities outstanding at September
30, 2018 and 2017, respectively, are presented below. Securities outstanding at September 30, 2017 were excluded from the computation
of income (loss) per share because they would have been anti-dilutive.
|
|
September 30,
2018
|
|
|
September 30,
2017
|
|
Warrants
|
|
|
11,293,211
|
|
|
|
12,204,580
|
|
Options
|
|
|
8,713,207
|
|
|
|
6,856,691
|
|
|
|
|
20,006,418
|
|
|
|
19,061,271
|
|
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 September
30, 2018, the Company had available 1,802,115 shares remaining for future awards under the OIP.
During the three and nine months ended September
30, 2018, the Company issued stock option awards from the OIP for 0 and 1,431,841 shares, respectively, 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 are scheduled to vest upon the
attainment of various milestones. During the three and nine months ended September 30, 2017, the Company issued stock option awards
from the OIP for 20,000 and 1,392,000 shares, respectively, 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 nine months ended September
30, 2018, the Company recorded compensation expense related to stock option awards granted under the OIP of $472,833 and $2,718,937,
respectively ($259,415 and $582,398 for the three and nine months ended September 30, 2017, respectively). The compensation expense
for the nine months ended September 30, 2018 includes compensation expense in the amount of $1,226,825 recognized in the second
quarter of 2018 when 900,000 stock options vested upon of the death of the Company’s Senior Vice President of Science and
Regulatory Affairs on April 19, 2018.
As of September 30, 2018, unrecognized compensation
expense related to non-vested stock options amounted to approximately $3,166,000, which is expected to be recognized as follows:
approximately $468,000, $1,110,000, $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 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 nine months ended
September 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
|
|
|
|
5.14 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
|
|
|
(371,134
|
)
|
|
$
|
0.83
|
|
|
|
|
|
|
|
|
|
Expired / cancelled in 2018
|
|
|
(504,191
|
)
|
|
$
|
1.71
|
|
|
|
|
|
|
|
|
|
Outstanding at September 30, 2018
|
|
|
8,713,207
|
|
|
$
|
1.50
|
|
|
|
6.0 years
|
|
|
$
|
10,628,107
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at September 30, 2018
|
|
|
5,310,124
|
|
|
$
|
1.33
|
|
|
|
4.6 years
|
|
|
$
|
7,264,390
|
|
The weighted average grant date fair value
of options issued during the nine months ended September 30, 2018 and 2017 was $1.80 and $0.98, respectively. The total fair value
of options that vested during the nine months ended September 30, 2018 and 2017 amounted to $2,392,207 and $750,265, respectively.
There were 371,134 options exercised on a cash and cashless basis during the nine months ended September 30, 2018 resulting in
the issuance of 342,089 shares and proceeds of $217,500 to the Company. There were 85,988 options exercised on a cashless basis
during the nine months ended September 30, 2017 resulting in the issuance of 51,927 shares of the Company’s common stock.