UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s Proxy Statement for its 2024 Annual Meeting of Stockholders are incorporated herein by reference in Part III of this Annual Report on Form 10-K. Such Proxy Statement will be filed with the Securities and Exchange Commission within 120 days of December 31, 2023.
Table of Contents
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Cautionary Note Regarding Forward-Looking Statements and Risk Factor Summary
This Annual Report on Form 10-K contains forward-looking statements concerning our business, operations and financial performance and condition as well as our plans, objectives and expectations for our business operations and financial performance and condition that are subject to risks and uncertainties. All statements other than statements of historical fact included in this Annual Report on Form 10-K are forward-looking statements. You can identify these statements by words such as “aim,” “anticipate,” “assume,” “believe,” “could,” “due,” “estimate,” “expect,” “goal,” “intend,” “may,” “objective,” “plan,” “potential,” “positioned,” “predict,” “should,” “target,” “will,” “would” and other similar expressions that are predictions of or indicate future events and future trends. These forward-looking statements are based on current expectations, estimates, forecasts and projections about our business and the industry in which we operate and our management’s beliefs and assumptions. These statements are not guarantees of future performance or development and involve known and unknown risks, uncertainties and other factors that are in some cases beyond our control. All forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those that we expected, including the following summary of risks related to our business:
| ● | We have had a history of losses and negative cash flows, and we may be unable to achieve and sustain profitability and positive cash flows from operations. |
| ● | Our ability to continue as a going concern. |
| ● | Our ability to regain compliance with the NASDAQ listing requirements. |
| ● | Our competitors generally have, and any future competitors may have, greater financial resources and name recognition than we do, and they may therefore develop products or other technologies similar or superior to ours, or otherwise compete more successfully than we do. |
| ● | Our research and development process may not develop marketable products, which would result in loss of our investment into such process. |
| ● | The failure of our information systems to function as intended or their penetration by outside parties with the intent to corrupt them could result in business disruption, litigation and regulatory action, and loss of revenue, assets, or personal or confidential data (cybersecurity). |
| ● | We may be unsuccessful at commercializing our Very Low Nicotine “VLN” tobacco using the reduced exposure claims authorized by the Food and Drug Administration (“FDA”). |
| ● | The manufacturing of tobacco products subjects us to significant governmental regulation and the failure to comply with such regulations could have a material adverse effect on our business and subject us to substantial fines or other regulatory actions. |
| ● | We may become subject to litigation related to cigarette smoking and/or exposure to environmental tobacco smoke, or ETS, which could severely impair our results of operations and liquidity. |
| ● | The loss of a significant customer for whom we manufacture tobacco products could have an adverse impact on our results of operation. |
| ● | Product liability claims, product recalls, or other claims could cause us to incur losses or damage our reputation. |
| ● | The FDA could force the removal of our products from the U.S. market. |
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| ● | Certain of our proprietary rights have expired or may expire or may not otherwise adequately protect our intellectual property, products and potential products, and if we cannot obtain adequate protection of our intellectual property, products and potential products, we may not be able to successfully market our products and potential products. |
| ● | We license certain patent rights from third-party owners. If such owners do not properly maintain or enforce the patents underlying such licenses, our competitive position and business prospects could be harmed. |
| ● | Our stock price may be highly volatile and could decline in value. |
| ● | We are a named defendant in certain litigation matters, including federal securities class action lawsuits and derivative complaints; if we are unable to resolve these matters favorably, then our business, operating results and financial condition may be adversely affected. |
| ● | Future sales of our common stock will result in dilution to our common stockholders. |
| ● | We do not expect to declare any dividends on our common stock in the foreseeable future. |
For the discussion of these risks and uncertainties and others that could cause actual results to differ materially from those contained in our forward-looking statements, please refer to “Risk Factors” in this Annual Report on Form 10-K. The forward-looking statements included in this Annual Report on Form 10-K are made only as of the date hereof. We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as otherwise required by law.
Unless the context otherwise requires, references to the “Company” “we” “us” and “our” refer to 22nd Century Group, Inc., a Nevada corporation, and its direct and indirect subsidiaries.
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PART I
Item 1.Business.
Overview
22nd Century Group, Inc. is a tobacco products company with sales and distribution of our own proprietary new reduced nicotine tobacco products authorized as Modified Risk Tobacco Products by the FDA. Additionally, we provide contract manufacturing services for conventional combustible tobacco products for third-party brands.
Our mission in tobacco is dedicated to mitigating the harms of smoking through our proprietary reduced nicotine content (“RNC”) tobacco plants and our Very Low Nicotine, VLN® combustible cigarette products. In December 2021, we secured the first and only authorization from the FDA to market a combustible cigarette, our brand VLN® as a Modified Risk Tobacco Product (“MRTP”) using certain reduced nicotine exposure claims. In April 2022, the inaugural launch of our proprietary VLN® cigarettes commenced through a pilot program in select Circle K stores in and around Chicago, Illinois. Building on the success of the pilot, we initiated a phased rollout strategy in 2023, progressing state by state and region by region to a store footprint spanning more than 5,000 stores in 26 states. Our VLN® tobacco products are supported by a substantial intellectual property portfolio comprising issued patents and patent applications related to tobacco plants, and in particular our reduced nicotine tobacco plants.
In addition to continued focus on VLN®, we renewed our focus on utilizing our tobacco assets to attract additional tobacco business to help fund the growth of VLN®. In addition to existing business relationships with multiple tobacco products companies, we will continue to expand the number of brands in our contract manufacturing operations (“CMO”) portfolio in 2024.
GVB Divestiture
On December 22, 2023, we completed the sale of substantially all of the GVB hemp/cannabis business (referred to as the “GVB Divestiture”). As a result, we have classified the results of operations of the hemp/cannabis segment and disposal group as discontinued operations in the Consolidated Statements of Operations for all periods presented. Additionally, the associated assets and liabilities linked to the discontinued operations have been designated as held for sale in the Consolidated Balance Sheet as of December 31, 2023 and 2022, respectively. All results and information presented exclude the hemp/cannabis segment and disposal group unless otherwise noted. For more detailed information regarding the divestiture, please refer to Note 2, titled “Discontinued Operations and Divestiture,” in the Notes to Consolidated Financial Statements, which can be found in Item 15 of this report.
Tobacco Overview
Our unwavering commitment is centered around reducing the effects of nicotine from smoking and smoking cessation. We believe we can achieve this mission through the commercialization of our proprietary RNC tobacco plants and cigarette products, prominently featured in our VLN® brand. These products contain 95% less nicotine content compared to conventional tobacco and cigarettes, which are intended to help users smoke less. The urgency of our mission is underscored by alarming statistics – the FDA publicly acknowledged on July 28, 2017, that tobacco use remains the leading cause of preventable disease and death in the United States. The repercussions include over 480,000 deaths annually and an economic toll of nearly $300 billion in lost productivity and direct health care costs, as reported the U.S. Centers for Disease Control and Prevention (“CDC”).
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Our innovative approach involves utilizing both genetically modified organism (“GMO”) and non-GMO methods to modify and develop proprietary bright, burley, and oriental RNC tobaccos, ensuring they grow with at least 95% less nicotine content. Our SPECTRUM® research cigarettes, developed in collaboration with independent researchers, officials from the FDA, the National Institute on Drug Abuse (“NIDA”), which is part of the National Institutes of Health (“NIH”), the National Cancer Institute (“NCI”), and the CDC, have played and continue to play a crucial role in independent clinical studies, with more than 32.8 million variable nicotine research cigarettes provided since 2011. The extensive body of scientific evidenced derived from these studies, published in peer-reviewed journals, including the New England Journal of Medicine and the Journal of the American Medical Association, supports the potential impact of our RNC tobaccos. Smokers who opt for our RNC cigarettes in clinical studies experienced reductions in smoking (measured in cigarettes per day), nicotine exposure, and dependence, coupled with minimal or no evidence of compensatory smoking or withdrawal and without serious adverse events. A list of ongoing as well as completed and published clinical studies using cigarettes made with our RNC tobaccos may be viewed at https://www.xxiicentury.com/vln-clinical-studies/published-clinical-studies-on-very-low-nicotine-content-vlnc-cigarettes. These studies showed that smokers who used for RNC cigarettes increased their frequency of smoke-free days and doubled their efforts to quit smoking. SPECTRUM® research cigarettes persist as a key component in various independent scientific studies, aimed at substantiating the public health advantage acknowledged by the FDA and other entities. This advantage is associated with the FDA’s proposal to establish a national product standard requiring that all cigarettes incorporate “minimally or nonaddictive” levels of nicotine. Notably, our SPECTRUM® variable nicotine research cigarettes serve as the precursor to our innovative VLN® cigarette products.
Our conviction in the significant global market potential of our proprietary RNC cigarettes, marketed under the brand name VLN®, is rooted in substantial data. As outlined in a 2021 report by the Foundation for a Smoke Free World, global full nicotine cigarette retail sales reached an estimated 84.1% or $612 billion of the $853 billion market for products that contain nicotine. The statistics from the CDC and the World Health Organization (“WHO”) highlight a substantial market, with over 1 billion global adult smokers and 30 million in the U.S.
Despite the prevalence of various nicotine delivery systems, including vaping, our belief is that smokers are actively seeking alternatives to traditional addictive combustible cigarettes. Our confidence is reinforced by consumer perception studies, in which 60% of adult smokers expressed a likelihood to adopt VLN® as their preferred choice. Importantly, VLN® is currently available in the market for sale, positioning itself as a viable option for smokers seeking reduced harm alternatives.
Our VLN® cigarettes are currently available in a large number of top U.S. markets and present a groundbreaking alternative with 95% less nicotine content than conventional cigarettes. Maintaining a familiar combustible product format, VLN® replicates the conventional cigarette smoking experience, encompassing sensory and experiential elements such as taste, scent, smell, and the familiar “hand-to-mouth” behavior.
The tobacco in VLN® cigarettes is meticulously crafted to contain a targeted 0.5 milligrams of nicotine per gram of tobacco, a threshold recognized by the FDA, based on clinical studies, as “minimally or non-addictive.” We believe the reduced nicotine content of VLN® can establish a dissociation between the act of smoking and the rapid introduction of nicotine to the bloodstream, which extensive clinical data indicates helps smokers to smoke less and potentially quit.
The results of numerous completed studies serve as an independent scientific foundation for the FDA’s advanced notice of proposed rule-making (“ANPRM”) on July 28, 2017, which announced FDA’s intention to institute a new rule to require that all combustible cigarettes sold in the United States contain only minimally or non-addictive levels of nicotine, also referred to as the Comprehensive Plan for Tobacco and Nicotine Regulation. Although this proposal has not yet been finalized or adopted by the FDA, the announcement supported our decision to submit and seek modified risk orders under MRTP applications (“MRTPAs”) for our VLN products. On December 23, 2021, we received authorization to market our VLN® cigarettes as a Modified Risk Tobacco Product (“MRTP”) using certain modified exposure claims.
We initiated efforts to offer our proprietary VLN® cigarettes for domestic sale after receiving the modified risk granted order. Furthermore, we continue to plan to evaluate opportunities to make VLN® available for international sale or licensing by third parties.
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Proposed Government Mandates Limiting the Nicotine in Cigarettes.
In a press release dated June 16, 2010, Dr. David Kessler, a former FDA Commissioner, advocated for swift action by the FDA to decrease nicotine levels in cigarettes to non-addictive thresholds. Dr. Kessler emphasized that lowering the stimulus level would consequently diminish cravings, deeming it the “ultimate harm reduction strategy.” Shortly thereafter, in a Washington Post article, Dr. Kessler proposed reducing the nicotine content in cigarettes from approximately 10 milligrams to less than 1 milligram. Notably, VLN® cigarettes contain between 0.3 to 0.7 mg/g.
In 2015, the WHO Study Group on Tobacco Product Regulation issued an advisory note endorsing a global nicotine reduction strategy, urging limitations on the sale of cigarettes to brands with nicotine content insufficient for addiction development or maintenance. Although the WHO did not specify absolute threshold for addiction, it suggested a likely threshold equal to or possibly less than 0.4 mg/g of dry cigarette tobacco filler. Our proprietary SPECTRUM® research cigarettes were cited in the WHO study as meeting this low nicotine level criterion at 0.4 mg/g of cigarette tobacco filler.
The WHO report concluded that establishing a maximum allowable nicotine content for all cigarettes could (i) reduce the initiation of smoking and progression to addiction, (ii) decrease smoking prevalence among addicted smokers through behavioral extinction, and (iii) increase quit rates while reducing relapse rates. Emphasizing population-wide benefits, the report highlighted the potential decrease in combusted tobacco use among current cigarette smokers and the prevention of non-smokers, particularly young people, from developing addiction to cigarettes.
On July 28, 2017, in connection with the ANPRM then-FDA Commissioner Scott Gottlieb, M.D., announced the FDA’s intention to use its authority under the Tobacco Control Act to require that all combustible cigarettes sold in the United States contain only minimally or non-addictive levels of nicotine. We believe this announcement marked a significant step towards reducing the addictive nature of cigarettes.
Following this announcement, on August 16, 2017, FDA Commissioner Scott Gottlieb, M.D., and Mitchell Zeller, J.D., the Director of the FDA’s Center for Tobacco Products (“FDA/CTP”), authored and titled “A Nicotine-Focused Framework of Public Health,” published in The New England Journal of Medicine. The article discussed the regulatory tool provided by the Tobacco Control Act, known as a tobacco “product standard,” which could be employed to alter the addictiveness of combustible cigarettes. While the statute prohibited reducing nicotine yields to zero, the FDA asserted its clear authority to otherwise reduce nicotine levels. The conclusion drawn was that a nicotine-limiting standard could render cigarettes minimally or non-addictive, aiding current users in quitting and preventing most future users from developing addiction. The FDA emphasized its commitment to being guided by scientific principles in shaping health policy. This commitment was reiterated in the context of addressing nicotine levels in cigarettes, underlining the importance of evidence-based decision-making.
We believe that recent political changes and perceptions towards nicotine addiction have the potential to be favorable to our business prospects from a policy priority and regulatory standpoint. Under the new leadership at the FDA and Center for Tobacco Products (“CTP”), we believe that the FDA could refocus on implementing its ground-breaking Comprehensive Plan for Tobacco and Nicotine Regulation, and specifically could renew efforts to cap the amount of nicotine in combustible cigarettes to a “minimally or non-addictive” level. We believe that the MRTP authorization and the launch of our VLN® cigarettes could serve as a powerful catalyst supporting any such policies.
For example, on January 27, 2022, the FDA posted an update on its FDA Voices site stating that it “remains on track” with its plans to prohibit menthol in combustible tobacco products. The FDA published a proposed tobacco product standard to ban menthol as a characterizing flavor in cigarettes in April 2022. The proposed FDA rule includes a process for firms to request an exemption from the standard for specific products of certain types on a case-by-case basis, indicating “reduced nicotine” as an example of such an exemption. On August 1, 2022, we submitted public comments in support of a tobacco product standard for menthol in cigarettes.
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In June 2022, the FDA announced that the Biden-Harris Administration published plans for future regulatory action that includes the FDA’s plans to develop a proposed product standard that would establish a maximum nicotine level to reduce the addictiveness of cigarettes and certain other combusted tobacco products. On June 21, 2022, a proposed rule for a tobacco product standard for nicotine level of certain tobacco products was published in the Spring 2022 Unified Agenda of Regulatory and Deregulatory Actions.
In late October 2022, in coordination with the FDA, the National Institute on Drug Abuse (NIDA), and others, we received an order for 2.8 million variable nicotine cigarettes. We believe our research cigarettes will continue to fuel numerous independent, scientific studies that could evaluate the potential benefits suggested by the FDA and others of implementing a national standard requiring all cigarettes to contain minimally or non-addictive levels of nicotine.
The FDA rule making process continued to advance throughout 2023 on both the proposed menthol ban and the proposed reduced nicotine content standard, but announcement of an FDA proposed rule was delayed multiple times for additional public comment and analysis.
We continue to advance on our reduced nicotine technology as we believe that our next generation, non-GMO plant research is the key to commercializing our reduced nicotine content tobacco and technology in international markets where non-GMO products are preferred or where GMO products are banned. Our patented, non-GMO technology can introduce very low nicotine traits into virtually any variety of tobacco, including bright, burley, and oriental. We have successfully applied our non-GMO technology to bright and burley varieties of tobacco and have initiated commercial growing activities for our non-GMO bright and burley reduced nicotine varieties. We anticipate commercial production of our American blend cigarettes featuring a mix of bright and burley VLN® tobacco varieties to begin in 2024.We believe that our RNC tobacco technology and our production and delivery of millions of proprietary variable nicotine research cigarettes since 2011 demonstrates the technical achievability of the FDA’s plan to dramatically reduce nicotine in cigarettes.
In the United States, we are focused on working with the FDA on its efforts to reduce nicotine in cigarettes. Outside the United States, we will focus on working with WHO-member countries that desire to utilize our proprietary RNC tobacco to implement the WHO recommendation of limiting the sale of cigarettes to brands with a nicotine content that is not sufficient to lead to development and/or maintenance of addiction.
Modified Risk Tobacco Products (MRTP)
The Family Smoking Prevention and Tobacco Control Act of 2009 (“Tobacco Control Act”) granted the FDA authority over the regulation of all tobacco products in the United States. The Tobacco Control Act further establishes procedures for the FDA to regulate the labeling and marketing of so-called MRTP, which includes, among other things tobacco products that may (i) reduce harm or the risk of tobacco-related disease or (ii) reduce or eliminate exposure to a substance. The Tobacco Control Act also includes provisions allowing the submission and authorization of a Premarket Tobacco Product Application (“PMTA”) for a new tobacco product, where the PMTA includes scientific data that demonstrates the new tobacco product is appropriate for the protection of public health.
On December 5, 2018, we submitted to the FDA a PMTA and on December 17, 2019, the FDA issued a marketing order in response to our PMTA. While the FDA’s marketing order authorized us to market the products in the U.S., it did not allow us to make reduced exposure claims which would indicate that the product contains 95% less nicotine. Marketing such reduced exposure claims requires the FDA to authorize an MRTPA.
Because of this, on December 27, 2018, we submitted to the FDA an MRTPA, seeking FDA authorization to market our reduced nicotine combustible cigarettes with certain reduced exposure claims. In the MRTPA, we requested authorization from the FDA to market our reduced nicotine tobacco cigarettes with certain product labeling claims under the brand name of VLN®.
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On December 23, 2021, we secured the first and only MRTP designation for a combustible cigarette for VLN® King and VLN® Menthol King 95% reduced nicotine content cigarettes. The FDA authorized the marketing of VLN® with the following reduced exposure claims: “95% less nicotine”, “Helps reduce your nicotine consumption”, and “Greatly reduces your nicotine consumption,”. The FDA also required that any use of these claims be accompanied by the statement that the product “Helps You Smoke Less,” which we consider an evidence-based claim supporting our products.
In previous years, we contracted with farmers to grow considerable quantities of RNC tobacco in anticipation of FDA authorization of our MRTP and subsequent commercial launch of VLN® cigarettes. In January 2022, at our manufacturing facility in North Carolina, we produced the first cartons of our VLN® reduced nicotine cigarettes, destined for commercial sale. In April 2022, we launched VLN® cigarettes in the U.S. market. We believe that the commercialization of VLN® cigarettes will create further opportunities for us to license our proprietary technology tobaccos and the VLN® brand.
VLN® Commercialization Plan
In April 2022, we initiated VLN® sales in more than 150 Circle K stores in the Chicago metro area through a pilot launch. After the pilot concluded and given the positive results, we made the decision to further deepen our reach in the state of Illinois and launch VLN® in Colorado to more than 3,000 potential locations across the state with our network of retailers and distribution partners, including Eagle Rock Distributing Company and Creager Mercantile.
The pilot enabled us to refine our VLN® rollout strategy and helped us develop our VLN® sales launch blueprint, an efficient, reproducible sales plan that focuses our resources to achieve the greatest returns. In November 2022, we announced that we intend to expand our VLN® launch to Arizona, New Mexico, and Utah, and announced plans to expand into up to 18 U.S. states over the following 12 months. In January 2023 we announced distribution partnerships with Core-Mark International and Eby-Brown Company, two of the largest convenience store distributors in the U.S., providing access to retailers in virtually every key U.S. market.
By concentrating and going deeper into select geographies and markets with high cigarette volume and large adult smoker populations, we believe we can capture greater market share effectively. We also plan to target states where there is a tax exemption for MRTP. As of March 1, 2024, we have secured regulatory authorizations to sell VLN® in 48 states and the District of Columbia. At year-end 2023, our phased rollout strategy, progressing state by state and region by region, had placed VLN into a store footprint spanning more than 5,000 stores in 26 states.
Tobacco Master Settlement Agreement
In September 2013, we entered into a Membership Interest Purchase Agreement (the “NASCO Acquisition”) to purchase all the issued and outstanding membership interests of NASCO, a federally licensed tobacco product manufacturer and subsequent participating manufacturer under the Master Settlement Agreement (“MSA”). The MSA is an accord reached in November 1998 between the State Attorneys General of 46 states, five U.S. territories, the District of Columbia and the five largest tobacco companies in the United States concerning the advertising, marketing and promotion of tobacco products. The MSA also set standards for, and imposes restrictions on, the sale and marketing of cigarettes by participating cigarette manufacturers. On August 29, 2014, we entered into an Amended Adherence Agreement with the 46 Settling States under the MSA pursuant to which the Company was approved to acquire NASCO and become a subsequent participating manufacturer under the MSA. On that same date, we closed the NASCO Acquisition and became a subsequent participating manufacturer under the MSA. NASCO has since been our wholly-owned subsidiary.
Tobacco Manufacturing
We lease our cigarette manufacturing facility and warehouse located in Mocksville, North Carolina. In 2013, we purchased certain (i) cigarette manufacturing equipment, and (ii) equipment parts, factory items, office furniture and fixtures, vehicles and computers from the bankruptcy estate of PTM Technologies, Inc. for approximately $3.2 million.
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The facility was primarily in a pre-manufacturing stage during 2014 as we sought approval during that time for us to become a subsequent participating manufacturer under the MSA. On August 29, 2014, we became a subsequent participating manufacturer under the MSA. Since 2015, we have manufactured and sold our SPECTRUM® variable nicotine research cigarettes, as well as third-party filtered cigar brands and MSA-compliant cigarette brands, at our factory in North Carolina.
The strategic acquisition of our factory has allowed us to become vertically integrated so that we can control production priorities/timing and maintain the required high quality of our products, including our SPECTRUM® research cigarettes and our MRTP-designated VLN® brand cigarettes featuring 95% less nicotine than the top 100 leading brands sold in the United States. In January 2022, our cigarette manufacturing facility began production of VLN® King and VLN® Menthol King cigarettes. With high-speed manufacturing capabilities we continue to attract additional CMO business to absorb our manufacturing overhead and help keep our unit cost profile low.
In 2023, we leased additional warehouse space in Winston-Salem, North Carolina. This bonded and temperature conditioned space will further support VLN® growth and provide additional distribution opportunities for customers.
Tobacco Sources of Raw Materials
We obtain our reduced nicotine tobacco leaf from third party-growers, primarily in multiple states in the United States who are under direct contracts with us. These contracts prohibit the transfer of our proprietary tobaccos, seeds and plant materials to any other party. We purchase conventional tobacco destined for contract manufacturing operations through third parties.
Research & Development (R&D) & Intellectual Property (IP)
Tobacco R&D
Since our inception, most of our research and development (“R&D”) efforts have been outsourced to highly qualified groups in their respective fields. Since 1998, we have had multiple R&D agreements with North Carolina State University (“NCSU”) and others resulting in exclusive worldwide licenses to various patented technologies. We have utilized the same model employed by many public-sector research organizations, which entails obtaining an exclusive option or license agreement to any invention arising out of our funded research. In all such cases, we fund and control all patent filings as the exclusive licensee. This model of contracting with public-sector researchers has enabled us to control R&D costs while achieving our desired results, including obtaining exclusive intellectual property rights relating to our outsourced R&D.
On June 22, 2018, we entered into an amendment to our existing license agreement with NCSU under which we exclusively licensed several bright and burley tobacco plant lines with Very Low Nicotine Content that are not genetically modified (non-GMO) plants. The amendment provided for us to pay NCSU a total exclusive license fee of $1.2 million. We will also pay running royalties to NCSU based on a portion of the net sales revenue received by us from sales of products that contain any portions of the plant materials that have been received by us from NCSU.
On October 22, 2018, we entered into a license agreement with the University of Kentucky (“UK”) to license on a non-exclusive basis a next-generation very low nicotine content burley tobacco plant lines that are not genetically modified (non-GMO) plants. The UK license agreement provided for us to pay UK a total license fee of $1.2 million. We will also pay running royalties to UK based on a portion of the net sales revenue received from sales of products that contain any portions of the plant materials that have been received from UK.
On December 1, 2021, we relocated our laboratory from Buffalo, New York to Rockville, Maryland, where we were conducting our own proprietary research and development activities in tobacco. In February 2024, we relocated our laboratory activities to our Mocksville, NC manufacturing facility. This reduces the fixed cost of our research and development activities, plus provides us an advantage with the proximity to our factory and NCSU.
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In 2022, our R&D collaboration with NCSU delivered the proof of concept and field data for a new gene combination (non-GMO) to reduce nicotine below 95%. This unique gene combination enables the production of a better-quality leaf and an increase in yield. In January 2022, a utility patent to protect the new combination was filed. Our exclusive NCSU collaboration also yielded proof of concept and field data for Oriental lines with a 90-95% nicotine reduction. These results will give us the option in the future to produce VLN cigarettes that comprise burley, oriental, and bright tobacco thus improving overall quality. In addition, this year we extended our VLN production field trial to include new burley and flue-cured VLN (non-GMO).
We are currently developing new versions of our RNC cigarettes utilizing these non-GMO tobacco lines for future commercialization in the U.S. and globally.
Tobacco IP
Our intellectual property enables us to alter the level of nicotine and other nicotinic alkaloids in tobacco plants through genetic engineering and modern plant breeding. The basic techniques include, but are not limited to, those that are used in the production of genetically modified and gene-edited varieties of other crops, which are also known as “biotech crops.”
We have extensive patent protection and exclusive rights covering tobacco plants with altered nicotine content produced by modifying the expression of genes that control the biosynthesis of nicotine in the tobacco plant. Our patent families related to nicotine biosynthesis are expected to expire between 2026 and 2043, with certain extensions of terms in the U.S. applications resulting from patent term adjustments at the U.S. Patent and Trademark Office (a “patent family” is a set of patent applications and patents, filed in various countries, that relate to at least one common earlier application).
Plant variety protection (“PVP”) certificates are issued in the United States by the U.S. Department of Agriculture. A PVP certificate prevents anyone other than the owner/licensee from planting, propagating, selling, importing, or exporting a plant variety for twenty (20) years in the U.S. and, generally, for twenty (20) years in other member countries of the International Union for the Protection of New Varieties of Plants, known as UPOV, an international treaty concerning plant breeders’ rights. There are currently more than 70 countries that are members of UPOV. Our current RNC tobaccos are protected by our patent portfolio.
In addition to our patents, patent applications, and PVP certificates, we own various registered trademarks in the United States and around the world. In November 2023, we signed an additional reduced nicotine content technology license with NCSU, providing additional modes of efficiently producing reduced nicotine content tobacco plants and extending our IP portfolio. This license will provide exclusive rights to the technology until 2042.
Government Regulation
The development, testing, manufacturing, and marketing of our products and potential products are subject to extensive regulation by governmental authorities in the United States and throughout the world.
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FDA Regulation of Tobacco Products
The Family Smoking Prevention and Tobacco Control Act (“Tobacco Control Act”) amended the Federal Food, Drug, and Cosmetic Act (“FDCA”) to provide the FDA with broad authority to regulate the manufacture, quality control, advertising, promotion, labeling, packaging, storage, distribution, recordkeeping, premarket authorization, post-authorization monitoring and post-authorization reporting of tobacco products, including our tobacco products. Among its authorities, the FDA requires that manufacturers of tobacco products first introduced or modified after February 15, 2007, undergo premarket review and obtain premarket authorization prior to commercialization. While the Tobacco Control Act prohibits the FDA from banning cigarettes outright, or mandating that nicotine levels be reduced to zero, it does allow the FDA to require the reduction of nicotine or other compounds in tobacco and cigarette smoke. The FDA has authority to restrict marketing and advertising, impose regulations on packaging, mandate warnings and disclosure of flavors or other ingredients, prohibit the sale of tobacco products with certain flavors or other characteristics, limit or prohibit the sale of tobacco products by certain retail establishments and the sale of tobacco products in certain packaging sizes, and seek to hold retailers and distributors responsible for the adverse health effects associated with both smoking and exposure to environmental tobacco smoke. In 2009, the Tobacco Control Act also banned all sales in the United States of cigarettes with flavored tobacco (other than menthol). As of June 2010, all cigarette companies were required to cease use of the terms “low tar,” “light” and “ultra light” in describing cigarettes sold in the United States.
The Tobacco Control Act, its implementing regulations and its 2016 deeming regulations establish broad FDA regulatory authority over all tobacco products and, among other provisions:
| ● | impose restrictions on the advertising, promotion, sale and distribution of tobacco products; |
| ● | establish pre-market review pathways for new and modified tobacco products; |
| ● | prohibit any express or implied claims that a tobacco product is or may be less harmful than other tobacco products without FDA authorization; |
| ● | authorize the FDA to impose tobacco product standards that are appropriate for the protection of the public health; and |
| ● | equip the FDA with a variety of investigatory and enforcement tools, including the authority to inspect product manufacturing and other facilities. |
The Tobacco Control Act requires manufacturers of tobacco products to, among, other things, provide FDA with a list of ingredients added to tobacco products in the manufacturing process and register any establishment engaged in the manufacture, preparation, or processing of a tobacco product. The manufacture of products is subject to strict quality control, testing and record-keeping requirements, and continuing obligations regarding the submission of safety reports and other post-market information. The FDA has several investigatory and enforcement tools available to it, including document requests and other required information submissions, facility inspections, examinations and investigations, injunction proceedings, monetary penalties, product withdrawal and recall orders, and product seizures.
The Tobacco Control Act also authorizes FDA to promulgate regulations requiring that the methods used in, and the facilities and controls used for, the manufacture, preproduction design validation, packing, and storage of a tobacco product conform to current good manufacturing practice (“CGMP”). On March 8, 2023, FDA issued a proposed rule to promulgate such regulations. The proposed rule, if finalized, would establish requirements for manufacturers of finished and bulk tobacco products on the methods used in, and the facilities and controls used for, the manufacture, pre-production design validation, packing, and storage of tobacco product.
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Regulation of Menthol Cigarettes
In April 2022, the FDA announced proposed product standards to prohibit menthol as a characterizing flavor in cigarettes) and prohibit all characterizing flavors (other than tobacco) in cigars. In January 2023, the Semi-Annual Agenda for Fall 2022 was released in the US. Here, the Department of Health and Human Services (HHS), stated that it intended to issue a final rule on Menthol in Cigarettes. This product standard, if enacted, would prohibit menthol as a characterizing flavor in cigarettes. Although this proposed rule was expected to be finalized in August 2023, its implementation has been delayed. There has been increasing activity on the state and local levels with respect to scrutiny of menthol and flavored tobacco products. For example, in 2022, the State of California banned tobacco retailers from selling most flavored and menthol tobacco products, including VLN® Menthol King. The state of Massachusetts has similar laws prohibiting the sale of flavored tobacco sales, including menthol cigarettes.
Premarket Tobacco Product Application (PMTA)
Certain of our products, including our low nicotine cigarettes, are marketed in the United States pursuant to a PMTA. Under Section 910(b) of the FDCA, a PMTA can be submitted for any new tobacco product seeking a marketing order to enable commercialization of a new tobacco product in the United States. For FDA to grant such an order, the PMTA must enable the FDA to determine that: (1) permitting the marketing of the new tobacco product would be appropriate for the protection of the public health; (2) the methods used in, or the facilities and controls used for, the manufacture, processing, or packing of the product conform to the requirements of Section 906(e) of the FD&C Act (21 U.S.C. 387f(e)); (3) the product labeling is not false or misleading in any particular; and (4) the product complies with any applicable product standard in effect under section 907 of the FDCA or that there is adequate information to justify a deviation from such standard. In determining whether to authorize a PMTA, FDA considers, among other things:
| ● | risks and benefits to the population as a whole, including people who would use the proposed new tobacco product as well as nonusers; |
| ● | whether people who currently use any tobacco product would be more or less likely to stop using such products if the proposed new tobacco product were available; |
| ● | whether people who currently do not use any tobacco products would be more or less likely to begin using tobacco products if the new product were available; and |
| ● | the methods, facilities, and controls used to manufacture, process, and pack the new tobacco product. |
Once a PMTA is submitted FDA conducts an initial acceptance review to determine whether the product falls under CTP jurisdiction and to confirm that the statutory and regulatory requirements of an application are met based upon the criteria set forth in the Tobacco Control Act. The FDA endeavors to complete its acceptance review within 21 to 60 days of receipt. If the application does not appear to contain the required information (except for product samples), the FDA may refuse to accept the application for review, and in either case, will notify the applicant. Once accepted for further review, the FDA makes a threshold determination of whether the application contains enough information to permit a substantive review, referred to as “filing,” and may refuse to file any application that does not include sufficient information. Once filed, the FDA intends to complete its review of a PMTA within 180 days of receipt, however the FDA’s review period may be paused or even restarted in response to new information from the applicant, and as such, FDA’s review may take significantly longer than expected. After the FDA completes its review of a PMTA, the FDA may issue a marketing denial order letter, or issue a marketing granted order letter. A marketing granted order becomes effective on the date it is issued in response to a PMTA and permits the new tobacco product to be legally marketed in the United States.
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A marketing order may include restrictions on the sale and distribution of the product, including restrictions on the access to, and the advertising and promotion of, the tobacco product, and unique requirements for record-keeping and post market reporting, among other things. Holders of authorized PMTAs are, among other things, required to submit detailed periodic and annual reports to the FDA within specified timelines, and are further required to submit reports for serious and unexpected adverse events associated with the product. Once granted the FDA may suspend or withdraw any marketing order on various grounds, such as a determination that the continued marketing of the tobacco product is no longer appropriate for the protection of public health, or where the PMTA holder has failed to comply with applicable post-market requirements.
Modified Risk Tobacco Products (MRTP)
Certain of our products, including our VLN® cigarettes, are marketed in the United States as MRTPs. MRTPs are tobacco products that are sold or distributed for use to reduce harm, or the risk of tobacco-related disease associated with commercially marketed tobacco products. Before an MRTP can be introduced or delivered into interstate commerce in the United States, the FDA must issue a either a “risk modification order” or “exposure modification order” pursuant to the Tobacco Control Act. An order permitting the sale of an MRTP, if granted by the FDA, enables the applicant to utilize certain claims with respect to a single, specific product, not an entire class of tobacco products.
To obtain a risk modification order under the FDCA, an applicant must demonstrate that the product, as it is actually used by consumers, will: (i) significantly reduce harm and the risk of tobacco-related disease to individual tobacco users; and (ii) benefit the health of the population as a whole; taking into account both users of tobacco products and persons who do not currently use tobacco products. To obtain an exposure modification order under the FDCA, an applicant must demonstrate that:
| ● | such an order would be appropriate to promote the public health; |
| ● | any aspect of the label, labeling, and advertising for the product that would cause the product to be a modified risk tobacco product is limited to an explicit or implicit representation that the tobacco product or its smoke does not contain or is free of a substance or contains a reduced level of a substance, or presents a reduced exposure to a substance in tobacco smoke; |
| ● | scientific evidence is not available and, using the best available scientific methods, cannot be made available without conducting long-term epidemiological studies for an application to meet the standards for obtaining a risk modification order; and |
| ● | the scientific evidence that is available without conducting long-term epidemiological studies demonstrates that a measurable and substantial reduction in morbidity or mortality among individual tobacco users is reasonably likely in subsequent studies. |
Furthermore, for FDA to issue an exposure modification order, FDA must find, among other things, that the applicant has demonstrated that the magnitude of overall reductions in exposure to the substance specified in the application is substantial, that such substance is harmful, that the product as actually used exposes consumers to the specified reduced level of the substance or substances, and will not expose them to higher levels of other harmful substances similar marketed products, unless such increases are minimal and the reasonably likely overall impact of use of the product remains a substantial and measurable reduction in overall morbidity and mortality among individual tobacco users. Notably the FDA also requires the applicant to demonstrate, through testing of actual consumer perception, that consumers will not be misled into believing that the product is or has been demonstrated to be less harmful or presents less of a risk of disease than other commercially marketed tobacco products.
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Similar to its review of PMTAs, once an MRTPA is submitted FDA conducts an initial acceptance review to determine whether the product falls under CTP jurisdiction and to confirm that the statutory and regulatory requirements of an application are met based upon the criteria set forth in the Tobacco Control Act. If the application does not appear to contain the required information, the FDA may refuse to accept the application for review. If and when the MRTP is accepted for further review, the FDA conducts a preliminary scientific review to ensure the application contains the information required for MRTPAs under the FDCA, a process referred to as “filing,” and the FDA may refuse to file any application that does not include the required information. Once filed, the FDA intends to complete its review of the PMTA within 360 days of receipt, however the FDA’s review may take significantly longer. As part of its substantive review, the FDA is required to send the application to the Tobacco Products Scientific Advisory Committee (“TPSAC”) and ask the TPSAC to report its recommendations on the application to the FDA within 60 days. After the FDA completes its review of the MRTPA, including the views expressed by the TPSAC, the FDA may issue a modified risk order letter, or issue a no modified risk order letter. If the FDA grants a risk modification order, the applicant must submit protocols for required post market surveillance for FDA concurrence within 30 days after receiving notice that they are required to conduct such surveillance. If the FDA grants an exposure modification order, the applicant must agree to conduct post market surveillance and studies in accordance with a protocol approved by the FDA. In either case, an FDA order permitting marketing of an MRTP is valid only for the fixed time period specified in the order and is not permanent, and such period may not be longer than five years. To continue marketing an MRTP after the set term, the company must submit a new MRTPA for FDA to determine that the product still satisfies the requirements set forth in the Tobacco Control Act.
Environmental Regulations
We are subject to a variety of federal, state and local environmental laws and regulations. We have developed specific programs across our business units for ensuring high standards of environmental compliance, including, standard operating practices and procedures at our manufacturing facility as well at our research and development centers. We believe that our manufacturing facility complies with all federal, state, and local environmental regulations, including the Clean Air Act, the Clean Water Act, and the Resource Conservation and Recovery Act.
In addition, any new products introduced by us are subject to a comprehensive environmental assessment by an independent third-party expert, including an assessment of how such products may create environmental risks. For our PMTA product, the FDA prepared a programmatic environmental assessment (PEA), based on our submitted data in accordance with the Council on Environmental Quality's regulations (40 CFR 1500-1508) implementing the National Environmental Policy Act (NEPA) and FDA’s NEPA regulations (21 CFR 25.40). The PEA concluded that the marketing orders would have no significant impact and that environmental impact statements would not be required.
Excise Taxes
Tobacco products are subject to substantial excise taxes in the U.S. and other countries. Significant increases in tobacco-related taxes or fees have been proposed or enacted and are likely to continue to be proposed or enacted at the federal, state and local levels within the U.S. and other countries. The frequency and magnitude of excise tax increases can be influenced by various factors, including the composition of executive and legislative bodies. Federal, state and local cigarette excise taxes have increased substantially over the past two decades. Tax increases have an adverse impact on sales of tobacco products.
Competition
Although our products are not approved as smoking cessation aids, we believe that our RNC tobacco cigarettes may compete with FDA-approved smoking cessation aids. In the market for FDA-approved smoking cessation aids, principal competitors would include Pfizer Inc., GlaxoSmithKline plc, Perrigo Company plc, Novartis International AG, and Niconovum AB, a subsidiary of Reynolds American Inc. The industry consists of major domestic and international companies, most of which have existing relationships in the markets into which we plan to sell, as well as financial, technical, marketing, sales, manufacturing, scaling capacity, distribution and other resources, and name recognition substantially greater than ours. We are also aware that several domestic cigarette companies and other research groups are working to research and grow reduced nicotine tobacco and have filed patent applications.
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Cigarette and filtered cigar companies compete primarily on the basis of product quality, brand recognition, brand loyalty, taste, innovation, packaging, service, marketing, advertising, retail shelf space, and price. Cigarette sales can be significantly influenced by weak economic conditions, erosion of consumer confidence, competitors’ introduction of low-price products or innovative products, higher taxes, higher absolute prices and larger gaps between price categories, and product regulation that diminishes the ability to differentiate tobacco products. Domestic cigarette competitors included Philip Morris USA Inc., Reynolds American Inc., ITG Brands, and Vector Group Ltd. International competitors included Philip Morris International Inc., British American Tobacco, JT International SA, Imperial Brands plc, and regional and local tobacco companies; and in some instances, government-owned tobacco enterprises such as the China National Tobacco Corporation.
Human Capital Resources
As of December 31, 2023, we had 64 employees. All employees are located in the United States. Our human capital resource objectives are designed to attract, and retain, highly motivated and well-qualified employees. We believe that we offer a competitive compensation package and have also worked diligently to provide a flexible and safe work environment.
Corporate Information
22nd Century Group, Inc. was incorporated under the laws of the State of Nevada on September 12, 2005 under the name Touchstone Mining Limited. On January 25, 2011, we entered into a reverse merger transaction with 22nd Century Limited, LLC, which we refer to herein as the “merger.” Upon the closing of the merger, 22nd Century Limited, LLC became our wholly-owned subsidiary. After the merger, we succeeded to the business of 22nd Century Limited, LLC as our sole line of business.
22nd Century Limited, LLC was originally formed as a New York limited liability company on February 20, 1998 as 21st Century Limited, LLC and subsequently merged with a newly-formed Delaware limited liability company, 22nd Century Limited, LLC, on November 29, 1999.
We are a Nevada corporation, and our corporate headquarters is located at 321 Farmington Road, Mocksville, North Carolina 27028. Our telephone number is (716) 270-1523. Our internet address is www.xxiicentury.com. All of our filings with the Securities and Exchange Commission, including our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q and Current Reports on Form 8-K can be accessed free of charge through our website promptly after filing; however, in the event that the website is inaccessible, we will provide paper copies of our most recent Annual Report on Form 10-K, the most recent Quarterly Report on Form 10-Q, Current Reports filed or furnished on Form 8-K, and all related amendments, excluding exhibits, free of charge upon request. These filings are also accessible on the SEC’s website at www.sec.gov. We do not incorporate the information on our website into this Annual Report on Form 10-K and our web site address is included as an inactive textual reference only.
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Item 1A. Risk Factors
You should carefully consider the risk factors set forth below and in other reports that we file from time to time with the Securities and Exchange Commission and the other information in this Annual Report on Form 10-K. The matters discussed in the risk factors, and additional risks and uncertainties not currently known to us or that we currently deem immaterial, could have a material adverse effect on our business, financial condition, results of operation and future growth prospects and could cause the trading price of our common stock to decline.
Risks Related to Our Business and Operations
We have a history of losses, and we expect to incur significant expenses and continuing losses for the foreseeable future and there is substantial doubt regarding our ability to continue as a going concern.
We have incurred significant losses and negative cash flows from operations since inception and expect to incur additional losses until such time that we can generate significant revenue and profit in our tobacco business, which casts substantial doubt regarding our ability to continue as a going concern. As of March 25, 2024, we had cash and cash equivalents of approximately $2.2 million.
Doubts about our ability to continue as a going concern have and could continue to negatively impact our relationships with our commercial partners and our ability, as part of our cost-cutting measures, to obtain, maintain, restructure and/or terminate agreements with them, or negatively impact our negotiating leverage with such parties, which could have a material adverse effect on our business, financial condition and results of operations or result in litigation. Furthermore, any loss of key personnel, employee attrition or material erosion of employee morale arising out of doubts about our ability to operate as a going concern could have a material adverse effect on our ability to effectively conduct our business, and could impair our ability to execute our business plan, thereby having a material adverse effect on our business, financial condition and results of operations.
We need additional funding to execute our business plan and to continue operations even with the proceeds from recent warrant inducement and exchange concluded in February 2024. We continue to seek and evaluate opportunities to raise additional funds through the issuance of our securities, asset sales, and through arrangements with strategic partners. If capital is not available to us when, and in the amounts needed, we could be required to liquidate our inventory and assets, cease or curtail operations, or seek protection under applicable bankruptcy laws or similar state proceedings. There can be no assurance that we will be able to raise the capital we need to continue our operations. Without additional capital, we will be unable to continue our operations in the future.
We may be unable to comply with the covenants in our senior secured debentures.
Our senior secured debentures contain customary representations, warranties and covenants including among other things and subject to certain exceptions, covenants that restrict us from incurring additional indebtedness, creating or permitting liens on assets, making or holding any investments, repaying outstanding indebtedness, paying dividends or distributions and entering into transactions with affiliates. We are also required to maintain certain quarterly revenue targets.
As a result of these covenants, our ability to respond to changes in business and economic conditions and engage in beneficial transactions, including to obtain additional financing as needed, may be restricted. Furthermore, our failure to comply with the covenants could result in a default under such agreements, which could permit the debt holders to accelerate our obligation to repay the debt. Although we recently received a waiver with respect to our compliance with such covenants, there is no assurance that we will be able to secure a similar waiver for the failure to comply with any future covenants. If any of our debt is accelerated, we likely would not have sufficient funds available to repay it. Substantially all of our assets, including intellectual property, are collateralized under the debentures. If such debt is accelerated, we could be required to liquidate our inventory, cease or curtail operations, or seek protection under applicable bankruptcy laws or similar state proceedings.
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Additionally, the senior secured debentures may be converted into shares of the Company’s common stock on the earlier of (i) June 30, 2024 and (ii) the public announcement of a Fundamental Transaction (as defined in the senior secured debentures). If the senior secured debentures are converted into common stock in whole or in part, the existing stockholders could incur significant dilution in their relative percentage ownership. The prospect of this possible dilution may also impact the price of our common stock.
We could continue to incur restructuring and impairment charges as we continue to pursue a cost cutting initiative and pursue strategic alternatives.
We continue to evaluate opportunities to optimize the cost structure of our operations in order to implement a cost savings initiative. The actions driven from these opportunities could result in significant charges which could adversely affect our financial condition and results of operations. Future actions could result in restructuring and related charges, including but not limited to impairments and employee termination costs and costs associated with terminating contracts that could be significant. We have incurred significant impairment charges for long-lived assets, including goodwill and intangible assets, which are subject to periodic impairment analysis and review, and remain subject to the potential for additional charges. Identifying and assessing whether impairment indicators exist, or if events or changes in circumstances have occurred, including market conditions, operating results, competition and general economic conditions, requires significant judgment. Any of the above future actions could result in charges that could have an adverse effect on our financial condition and results of operations. The cost-cutting initiatives have led, and may continue to lead, to legal claims by service providers and other third-parties. Any resulting litigation could be costly and time consuming and an unfavorable outcome could have a significant adverse effect on our business.
Our competitors generally have, and any future competitors may have, greater financial resources and name recognition than we do, and they may therefore develop products or other technologies similar or superior to ours, or otherwise compete more successfully than we do.
We are competing with large tobacco companies and large pharmaceutical companies that have greater resources that us. The tobacco industry consists of major domestic and international companies, most of which have existing relationships in the markets in which we plan to sell, as well as financial, technical, research and development, marketing, sales, manufacturing, scaling capacity, distribution, lobbying and other resources and name recognition substantially greater than ours. In addition, we expect new competitors will enter the markets for similar tobacco products in the future and the nature and extent of this market entrance cannot be quantified at this time.
Potential customers may choose to do business with more established competitors because of their perception that our competitors are more stable, can scale operations more quickly, have greater manufacturing capacity, have robust marketing and sale programs and lend greater credibility to governmental regulators and others. In addition, large companies have the ability to provide entry-level pricing for premium products in order make us less competitive. If we are unable to compete successfully against larger companies with more financial resources and name recognition, our business and prospects would be materially adversely affected.
Our competitors may develop products that are less expensive, safer or otherwise more appealing, which may diminish or eliminate the commercial success of our VLN® cigarettes or any other potential products that we may commercialize.
If our competitors develop very low nicotine tobacco without infringing on our intellectual property or other products that are less expensive, safer or otherwise more appealing than our RNC cigarettes or any of our other potential products, or that reach the market before ours, we may not achieve commercial success. Currently, there are numerous companies developing products for which they may submit MRTPAs, working to develop low nicotine tobacco and other tobacco alternative products to provide products that are potentially safer for human consumption or to otherwise assist consumers to cease or begin to switch from smoking. If one of such competitors develops a cigarette that is safe for human consumption, a safer alternative for nicotine that is widely accepted, superior low nicotine tobacco or
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otherwise develops a superior quitting method, it could render our RNC tobacco and cigarettes obsolete, which would have a material adverse impact on our business and operations and our ability to achieve profitability.
Our competitors may render our technologies obsolete by advances in existing technological approaches or the development of new or different approaches, potentially eliminating the advantages that we believe we derive from our research approach and proprietary technologies.
Our competitors may:
| ● | develop and market similar or new products that are less expensive, safer, or otherwise more appealing than our products; |
| ● | develop similar or new technologies and products that render our products obsolete; |
| ● | operate larger research and development programs or have substantially greater financial resources than we do; |
| ● | have greater success in recruiting skilled technical and scientific workers from the limited pool of available talent; |
| ● | more effectively negotiate third-party licenses and strategic relationships; |
| ● | commercialize competing products before we or our partners can launch our products; |
| ● | be more effective in marketing and creating brand awareness of their products that we are; |
| ● | develop tobacco with superior traits to ours; |
| ● | initiate or withstand substantial price competition more successfully than we can; and/or |
| ● | take advantage of acquisition or other opportunities more readily than we can. |
Our research and development process may not develop marketable products cost-effectively or at all, which would result in loss of our investment into such process.
We do not know whether our research and development process will result in marketable products. Even if we develop marketable products, we may not be able to obtain the necessary marketing authorizations for these potential products or our anticipated time of bringing these potential products to the market may be substantially delayed. The development of new products is costly, time-consuming, and has no guarantee of success. Any such delays or the inability to effectively develop new products in a cost-effective manner, or at all, would have a material adverse effect on our business and a loss of our financial resources.
We have in the past invested in other companies and may do so in the future, which may divert our management’s attention, result in additional dilution to our stockholders, and consume resources that are necessary to sustain our business or result in losses.
We may acquire or invest in complementary solutions, services, technologies, or businesses in the future. We may also enter into relationships with other businesses to expand our intellectual property portfolio, which could involve preferred or exclusive licenses or investments in other companies. Negotiating these transactions can be time-consuming, difficult and expensive, and our ability to complete these transactions may often be subject to conditions or approvals that are beyond our control. Consequently, these transactions, even if undertaken and announced, may not close or may not yield the benefits that we expect. Many of our acquisitions in the past have not yielded the results or synergies that we anticipated. In addition, we may only be able to conduct limited due diligence on an acquired company’s operations. Following an acquisition, we may be subject to liabilities arising from an acquired company’s past or present operations and these liabilities may be greater than the warranty and indemnity limitations that we negotiate. Any liability that is greater than these warranty and indemnity limitations could have a negative impact on our financial condition.
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Acquisitions may also disrupt our business, divert our resources, and require significant management attention that would otherwise be available for the development of our business. Moreover, the anticipated benefits of any acquisition, investment, or business relationship may not be realized or we may be exposed to unknown liabilities, including litigation against the companies that we may acquire.
The failure of our information systems to function as intended or their penetration by outside parties with the intent to corrupt them could result in business disruption, litigation and regulatory action, and loss of revenue, assets, or personal or confidential data (cybersecurity).
We use information systems to help manage business processes, collect and interpret business data and communicate internally and externally with employees, suppliers, customers and others. Some of these information systems are managed by third-party service providers. We have backup systems and business continuity plans in place, and we take care to protect our systems and data from unauthorized access. However, a failure of our systems to function as intended, or penetration of our systems by outside parties intent on extracting or corrupting information or otherwise disrupting business processes, could interrupt our business and place us at a competitive disadvantage, result in a loss of revenue, assets or personal or other sensitive data, litigation and regulatory action, cause damage to our reputation and that of our brands and result in significant remediation and other costs. Any cybersecurity incident could cause substantial harm to our business and result in regulatory action, fines, and/or substantial costs.
Business interruptions, whether caused by natural disaster, terrorism, economic downturns, global pandemics or other events, could negatively impact our business.
A natural disaster (such as an earthquake, hurricane, fire, or flood), pandemics, widespread power outage or internet failure or hack, or an act of terrorism could cause substantial delays in our operations, damage or destroy our equipment or facilities, and cause us to incur additional expenses and lose revenue. The insurance we maintain against natural disasters may not be adequate to cover our losses in any particular case, which would require us to expend significant resources to replace any destroyed assets, thereby materially and adversely affecting our financial condition and prospects. Other global incidents could have a similar effect of disrupting our business to the extent they reach and impact the areas in which we operate, the availability of inventory we need, the customers we serve, the partners on whom we rely for products or services or the employees who operate our businesses. For example, another pandemic or comparable heath concern could disrupt our supply chain for tobacco, as well as negatively impact employee productivity, including affecting the availability of employees reporting for work. Any business interruption caused by such unforeseen events could have a material adverse impact on our business and operations.
Our prior operations in the hemp/cannabis space could have a material adverse effect on our business, financial condition, and results of operations.
We previously operated in the cannabis space. The hemp plant and the marijuana plant are both part of the same cannabis genus of plant, except that hemp, by definition, has not more than 0.3% THC content and is legal under the federal 2018 Farm Bill and certain state laws, but the same plant with a higher THC content is defined as marijuana, which is legal under certain state laws, is not legal under federal law. The similarities between these plants can cause confusion, and our previous activities with legal hemp may be incorrectly perceived as us having been involved in federally illegal marijuana. Also, despite growing support for the marijuana industry and legalization of marijuana in certain U.S. states, many individuals and businesses remain opposed to the marijuana industry. Any negativity resulting from our prior cannabis operations could result in a loss of current or future business. It could also adversely affect the public’s perception of us and lead to reluctance by new parties to do business with us or to own our common stock. We cannot assure you that additional business partners, including but not limited to financial institutions, banking institutions and customers, will not attempt to end or curtail their relationships with us. Any such negative press or cessation of business could have a material adverse effect on our business, financial condition, and results of operations.
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Risks Related to the Tobacco Industry
We may be unsuccessful in our efforts to commercialize our RNC tobacco using the reduced exposure claims authorized by the FDA.
While the FDA issued an exposure modification order in connection with our MRTPA and we have been commercializing our VLN® cigarettes in select markets across the United States, there are no guarantees regarding the commercial viability of our RNC tobacco cigarettes. To date, there has never been a comparable product sold in the marketplace and we have only commercialized the cigarettes on a limited basis. We have obtained an exposure modification order for our VLN® cigarettes, which enables us to make certain claims regarding the reduction of nicotine within these products. Specifically, we are permitted to market the products with the claims “95% less nicotine,” “helps reduce your nicotine consumption,” and “greatly reduces your nicotine consumption,” and we are required to use the claim “helps you smoke less” in connection with the other authorized claims; we may not market our VLN cigarettes for claims that have not been authorized pursuant to an FDA order. Although we believe these claims have the potential to increase our product sales, these products may never achieve consumer acceptance at levels that make the product commercially viable for profitable sales. In addition, the process of commercializing such product and creating consumer awareness could take longer and cost more than we expect.
In addition, even if we believe that certain legislative or regulatory changes may increase product demand, such as the proposals that FDA has historically made with respect to requiring minimally or non-addictive levels of nicotine in all cigarettes sold in the U.S., there can be no assurance that such regulations, if implemented, would increase or create demand for our RNC cigarettes.
The commercial success of our RNC tobacco cigarettes will depend on a number of factors, including, but not limited to our ability to:
| ● | achieve, maintain and grow market identify of, acceptance of, and demand for, such products; |
| ● | successfully create consumer awareness of such products; |
| ● | market the product with the phrase “Helps You Smoke Less” and any other required warnings or statements; |
| ● | maintain, manage or scale the necessary sales, marketing, manufacturing and other capabilities and infrastructure that are required to successfully commercialize such products; |
| ● | grow or otherwise maintain an adequate supply of RNC tobacco; |
| ● | maintain and extend intellectual property protection for such products; |
| ● | comply with applicable legal and regulatory requirements, including FDA and MSA regulations or requirements with respect to product advertising and our obligations in connection with our PMTAs and MRTPs; |
| ● | competitively price our products; |
| ● | compete with other similar products or new technologies (if any); |
| ● | obtain cost-effective distribution outlets; and |
| ● | effectively sell our products into established markets where there is substantial market dominance by large tobacco enterprises. |
If we are unsuccessful in commercializing our RNC tobacco cigarettes, or such commercialization takes longer or costs more than we currently expect, our financial results, business and future prospects would be materially adversely effected.
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We have limited experience marketing and selling Modified Exposure Cigarettes and our working capital and inventory estimates based on demand expectations may be incorrect, which could harm our operating results and financial condition.
While members of management and our board of directors are experienced in the selling of conventional cigarette and other consumer products, we have limited experience in introducing a new low nicotine category for selling our VLN cigarettes pursuant to an exposure modification order. As we work to commercialize one or more of our products for sale, including our VLN cigarettes, we base our working capital and inventory decisions on management’s estimates of future demand. If demand for such potential new products does not increase as quickly as we have estimated, our inventory costs, demands on working capital, expenses could increase, and our business and operating results could suffer. Alternatively, if we experience sales that exceed our estimates, our working capital and inventory needs may be higher than those currently anticipated. Since our RNC tobacco is not widely available and must be grown specifically for our potential products, any shortage in such tobacco could prevent us from increasing sales to meet demand and any surplus could result in inventory obsolescence and become a total loss.
Our inability to incorrectly estimate demand for future products could negatively harm our operating results and financial condition.
The manufacturing and sale of tobacco products subjects us to significant governmental regulation and the failure to comply with such regulations could have a material adverse effect on our business and subject us to substantial fines or other regulatory actions.
Companies that manufacture and/or sell tobacco products face significant governmental regulation, especially in the United States pursuant to the Tobacco Control Act, including but not limited to efforts aimed at reducing the incidence of tobacco use, restricting marketing and advertising, imposing regulations on packaging, mandating warnings and disclosure of flavors or other ingredients, prohibiting the sale of tobacco products with certain flavors or other characteristics, requiring compliance with certain environmental standards, limiting or prohibiting the sale of tobacco products by certain retail establishments and the sale of tobacco products in certain packaging sizes, and seeking to hold retailers and distributors responsible for the adverse health effects associated with both smoking and exposure to environmental tobacco smoke.
The Tobacco Control Act requires manufacturers of tobacco products to, among other things, provide the FDA with a list of ingredients added to tobacco products in the manufacturing process and register any establishment engaged in the manufacture, preparation, or processing of a tobacco product. The manufacture of products is subject to strict quality control, testing and record-keeping requirements, and continuing obligations regarding the submission of safety reports and other post-market information. The Tobacco Control Act also authorizes the FDA to promulgate regulations requiring that the methods used in, and the facilities and controls used for, the manufacture, preproduction design validation, packing, and storage of a tobacco product conform to current good manufacturing practice (“CGMP”). On March 8, 2023, the FDA issued a proposed rule to promulgate such CGMP regulations. The proposed rule, if finalized, would establish requirements for manufacturers of finished and bulk tobacco products on the methods used in, and the facilities and controls used for, the manufacture, pre-production design validation, packing, and storage of tobacco product.
We cannot guarantee that our current manufacturing facility or any other manufacturing will successfully complete FDA inspections and/or similar inspections in foreign, or that future CGMP regulations will not also negatively affect the cost or sustainability of our manufacturing facility. Our failure to comply with applicable manufacturing regulations could result in sanctions being imposed on us, including fines, injunctions, civil penalties, delays, suspension or withdrawal of marketing orders, seizures or recalls, operating restrictions and criminal prosecutions, any of which could significantly and adversely affect our financial position. In addition, we and our customers for whom we manufacture tobacco products also face significant governmental regulation, including efforts aimed at reducing the incidence of tobacco use. We also cannot predict the likelihood, nature or extent of government regulation that may arise from future legislation or administrative action, either in the United States or abroad. Actions by the FDA and other foreign, federal, state or local governments or agencies may impact the adult tobacco consumer acceptability of or access to tobacco products (for example, through product standards proposed by the FDA for nicotine and flavors including menthol), delay or prevent the launch of new or modified tobacco products or products with reduced exposure claims,
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require the recall or other removal of tobacco products from the marketplace, impose additional manufacturing, labeling or packing requirements, interrupt manufacturing or otherwise significantly increase the cost of doing business. Any one or more of these actions may have a material adverse impact on us or the business of our customers for whom we make tobacco products, which could have a negative impact on our results of operations.
For example, the Tobacco Control Act requires the FDA to issue new cigarette health warnings that would include a color graphic component depicting the negative health consequences of smoking. In March 2020, the FDA published a final rule fulfilling this statutory requirement. The final rule, entitled “Required Warnings for Cigarette Packages and Advertisements,” specifies the 11 new textual warning label statements and accompanying color graphics that manufacturers would have to include with cigarette packaging and advertisements. On December 7, 2022, the U.S. District Court for the Eastern District of Texas vacated the final rule, and the case is currently pending before the U.S. Court of Appeals for the Fifth Circuit.
It is possible that significant regulatory developments will take place over the next few years across global markets, driven principally by the World Health Organization’s Framework Convention on Tobacco Control (“FCTC”). The FCTC is the first international public health treaty on tobacco, and its objective is to establish a global agenda for tobacco regulation with the purpose of reducing initiation of tobacco use and encouraging cessation. In addition, the FCTC has led to increased efforts by tobacco control advocates and public health organizations to reduce the appeal of tobacco products. Our operating results could be significantly affected by any significant increase in the cost of complying with new regulatory requirements.
Compliance with current and future regulations regarding tobacco could have a material impact on our business and operations and could result in fines, government actions to restrict or prevent sales of products, as well as result in substantial costs and expenses.
We may become subject to litigation related to cigarette smoking and/or exposure to environmental tobacco smoke, or ETS, which could severely impair our results of operations and liquidity.
Although we are not currently subject to legal proceedings related to cigarette smoking or ETS, we may become subject to litigation related to the sale of our Modified Exposure Cigarettes or other tobacco products we sell or manufacture in the future. Legal proceedings covering a wide range of matters related to tobacco use are pending or threatened in various U.S. and foreign jurisdictions. Various types of claims are raised in these proceedings, including product liability, consumer protection, antitrust, tax, contraband shipments, patent infringement, employment matters, claims for contribution, and claims of competitors and distributors.
Litigation is subject to uncertainty, and it is possible that there could be adverse developments in pending cases. An unfavorable outcome or settlement of pending tobacco related litigation could encourage the commencement of additional litigation. The variability in pleadings, together with the actual experience of management in litigating claims, demonstrates that the monetary relief that may be specified in a lawsuit bears little relevance to the ultimate outcome.
Damages claimed in some tobacco-related litigations are significant and, in certain cases, range into the billions of dollars. We anticipate that new cases will continue to be filed. The FCTC encourages litigation against tobacco product manufacturers. It is possible that our results of operations, cash flows, or financial position could be materially affected by an unfavorable outcome or settlement of litigation.
Our production facility (NASCO) is integral to our tobacco business and adverse changes or developments affecting our facility may have an adverse impact on our business.
Our production facility is integral to our tobacco business. Adverse changes or developments affecting this facility, including, but not limited to, disease or infestation of our raw materials, a fire, an explosion, a serious injury or fatality, a power failure, a natural disaster, an epidemic, pandemic or other public health crisis, or a material failure of our security infrastructure, could reduce or require us to entirely suspend operations.
A significant failure of our site security measures and other facility requirements, including failure to comply with applicable regulatory requirements, could have an impact on our ability to continue operating under our facility licenses and our prospects of renewing our licenses, and could also result in a suspension or revocation of these licenses.
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The loss of a significant customer for whom we manufacture tobacco products could have an adverse impact on our results of operation.
Currently, a significant portion of our revenues (and corresponding accounts receivable) from manufacturing tobacco products are derived from a small number of large customers, and we do not have agreements with such customers requiring them to purchase a minimum amount of products from us or guaranteeing any minimum future purchase amounts from us. Such customers may, at any time, delay or decrease their level of purchases from us or cease doing business with us altogether. Since many of our manufacturing costs are fixed, if sales to such customers cease or are reduced, we may not obtain sufficient purchase orders from other customers necessary to offset any such losses or reductions, which could have a negative impact on our results of operations.
Product liability claims, product recalls, or other claims could cause us to incur losses or damage our reputation.
The risk of product liability claims, product recalls, and associated adverse publicity, is inherent in the development, manufacturing, marketing, and sale of tobacco products. Any product recall or lawsuit seeking significant monetary damages may have a material adverse effect on our business and financial condition. A successful product liability claim against us could require us to pay a substantial monetary award. Though we currently have no pending product liability claims against us, we cannot assure you that such claims will not be made in the future and any such claim could cause us to incur substantial losses or damage our reputation.
Cigarettes are subject to substantial taxes. Significant increases in cigarette-related taxes have been proposed or enacted and are likely to continue to be proposed or enacted in numerous jurisdictions. These tax increases may affect the sales of our potential products and our third-parties customers’ tobacco products manufactured at our factory, which could result in decreased sales and profitability of our manufacturing business.
Tax regimes, including excise taxes, sales taxes, and import duties, can disproportionately affect the retail price of manufactured cigarettes versus other tobacco products, or disproportionately affect the relative retail price of our Modified Exposure Cigarettes versus lower-priced cigarette brands manufactured by our competitors. Increases in cigarette taxes are expected to continue to have an adverse impact on sales of cigarettes resulting in (i) lower consumption levels, (ii) a shift in sales from manufactured cigarettes to other tobacco products or to lower-price cigarette categories, (iii) a shift from local sales to legal cross-border purchases of lower price products, and (iv) illicit products such as contraband and counterfeit.
Government mandated prices or taxes, production control programs, shifts in crops driven by economic conditions, climatic or adverse weather patterns may increase the cost or reduce the quality and/or supply of the tobacco and other agricultural products used to manufacture our products.
We depend on a small number of independent tobacco farmers to grow our specialty proprietary tobaccos with specific nicotine contents for our products. As with other agricultural commodities, the price of tobacco leaf can be influenced by imbalances in supply and demand, and crop quality can be influenced by variations in weather patterns, diseases, and pests. This risk is greater for us, as there would be no alternative supply of RNC tobacco in the event that one of our growers experiences a material adverse event with respect to a particular RNC tobacco crop or the quantity or quality was not as we anticipated, and we would not be able to supply leaf for our VLN® cigarettes.
We must also compete with other tobacco companies for contract production with independent tobacco farmers. Tobacco production in certain countries is subject to a variety of controls, including government mandated prices and production control programs. Changes in the patterns of demand for agricultural products could cause farmers to plant less tobacco. Any significant change in tobacco leaf prices or taxes, quality and quantity could affect our profitability and our business.
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We distribute and sell our products outside of the U.S., which subjects us to other regulatory risks.
In addition to the authorization to market and sell our RNC tobacco cigarettes using modified risk claims in the U.S., we continue to seek governmental authorizations required to market our RNC tobacco cigarettes and our other products in other countries. Marketing of our products is not permitted in certain countries until we have obtained required authorizations or exemptions in these individual countries. The regulatory review process varies from country to country, and authorization by foreign governmental authorities is unpredictable, uncertain, and generally expensive. Our ability to market our potential products could be substantially limited due to delays in receipt of, or failure to receive, the necessary authorizations or exemptions. We anticipate commencing the applications required in some or all of these countries in the future. Failure to obtain necessary regulatory authorizations or exemptions could impair our ability to generate revenue from international sources.
We may become subject to governmental investigations on a range of matters.
Tobacco companies are often subject to investigations, including allegations of contraband shipments of cigarettes, allegations of unlawful pricing activities within certain markets, allegations of underpayment of custom duties and/or excise taxes, and allegations of false and misleading usage of descriptors such as “lights” and “ultra-lights.” We cannot predict the outcome of any investigations to which we may become subject, but we may be materially affected by an unfavorable outcome of potential future investigations.
Our business model inherently loses customers.
Our VLN® cigarette is designed to help people smoke less and eventually quit smoking completely. If our product is successful, we will lose customers as a result. A significant loss in VLN® customers, or our inability to add new VLN® customers faster than we lose customers, could prevent our VLN® business from growing and have a material negative impact on the results of our operations.
We may be unsuccessful in anticipating changes in adult consumer preferences, responding to changes in consumer purchase behavior or managing through difficult competitive and economic conditions, which could have an adverse effect on business.
In the tobacco industry, we are subject to intense competition and changes in adult consumer preferences. To be successful, we must:
| ● | anticipate and respond to new and evolving adult consumer preferences; |
| ● | develop, manufacture, market and distribute new and innovative products that appeal to adult consumers (including, where appropriate, through arrangements with, or investments in, third parties); |
| ● | improve productivity; and |
| ● | protect or enhance margins through cost savings and price increases. |
The willingness of adult consumers to purchase premium consumer tobacco products, such as our RNC cigarettes, depends in part on economic conditions. In periods of economic uncertainty, adult consumers may purchase more discount brands and/or, in the case of tobacco products, consider lower-priced tobacco products, which could have a material adverse effect on the business and profitability.
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We may be unsuccessful in developing and commercializing adjacent products or processes, including innovative tobacco products that may reduce the health risks associated with certain other tobacco products and that appeal to adult tobacco consumers.
Some innovative tobacco products may reduce the health risks associated with certain other tobacco products, while continuing to offer adult tobacco consumers products that meet their taste expectations and evolving preferences. Examples include tobacco-containing and nicotine-containing products that reduce or eliminate exposure to cigarette smoke and/or constituents identified by public health authorities as harmful, such as electronically heated tobacco products, oral nicotine pouches, and e-vapor products. We may not succeed in our efforts to develop and commercialize any adjacent products.
Further, we cannot predict whether regulators, including the FDA, will permit the marketing or sale of any particular innovative products (including products with claims of reduced risk to adult consumers), the speed with which they may make such determinations or whether regulators will impose an unduly burdensome regulatory framework on such products. In addition, the FDA could, for a variety of reasons, determine that innovative products currently on the market, or those that have previously received authorization, including with a claim of reduced exposure, are not appropriate for the public health and the FDA could require such products be taken off the market. We also cannot predict whether any products will appeal to adult tobacco consumers or whether adult tobacco consumers’ purchasing decisions would be affected by reduced-risk claims on such products if permitted. Adverse developments on any of these matters could negatively impact the commercial viability of such products.
If we do not succeed in our efforts to develop and commercialize innovative tobacco products or to obtain or maintain regulatory authorizations for the marketing or sale of products, including for the use of claims of reduced exposure, but one or more of our competitors does succeed, we may be at a competitive disadvantage, which could have an adverse effect on our ability to commercialize our products.
An extended disruption at a facility or in service by a supplier, distributor or distribution chain service provider could have a material adverse effect on our business.
We face risks inherent in reliance on one manufacturing facility and a small number of key suppliers, distributors and distribution chain service providers. A pandemic (including COVID-19), natural or man-made disaster or other disruption that affects the manufacturing operations, the operations of any key supplier, distributor or distribution chain service provider or any other disruption in the supply or distribution of goods or services (including a key supplier’s inability to comply with government regulations or unwillingness to supply goods or services to a tobacco company) could have a material adverse effect on our business.
The FDA could force the removal of our products from the U.S. market.
The FDA has broad authority over the regulation of tobacco products. The FDA could, among other things, force us to remove from the U.S. market our RNC tobacco cigarettes even after the FDA authorization on December 17, 2019 of our PMTA for us to market our RNC tobacco cigarettes, or the authorization of our MRTP application on December 23, 2021, to enable us to use certain modified exposure claims with respect to our VLN® cigarettes. In addition, the exposure modification order that enables us to market our VLN® cigarettes as MRTPs was granted for a period of five years, which is the maximum duration for a marketing granted order for such products under the Family Smoking Prevention & Tobacco Control Act (PUBLIC LAW 111–31—JUNE 22, 2009). Consequently, we will need to reapply to FDA under a new MRTP application to extend the FDA’s exposure modification order beyond December 23, 2026. The MRTP authorization process is a complex, substantial and lengthy regulatory undertaking. The FDA may or may not grant continued authorization of these product claims, including based on FDA's assessment of whether the product application(s) satisfy the statutory requirements for such an order, and whether we have adequately complied with the conditions imposed on us in connection with the FDA’s exposure modification order, such as requirements relating to recordkeeping, reporting and post-market studies. Any action by the FDA to remove our products from the U.S. market, including the termination or non-renewal of the exposure modification orders for our VLN® cigarettes would have a material adverse impact on our business.
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A ban on menthol or flavored tobacco products could have a material adverse impact on our business.
On April 27, 2022, the FDA proposed new rules to prohibit menthol as a characterizing flavor in cigarettes and prohibit all characterizing flavors (other than tobacco) in cigars. There has been increasing activity on the state and local levels with respect to scrutiny of menthol and flavored tobacco products, including a recent law passed by the State of California prohibiting tobacco retailers from selling most flavored and menthol tobacco products, including VLN® Menthol King. If these proposed rules are finalized and implemented, if new rules are proposed or if additional states or governments pass laws similar to the State of California, we could be negatively impacted through decreased sales, a requirement to remove non-compliant tobacco products from the marketplace, associated interruptions in manufacturing or business disruptions. In addition, although we believe that our VLN® Menthol King reduced nicotine cigarettes will be exempted from FDA’s menthol ban on cigarettes, there is no guarantee that they will be exempted by the FDA or any other state or local government. Accordingly, the implementation of these proposed or new laws or rules may have a material adverse impact on our results of operations.
Risks Related to Intellectual Property
Certain of our proprietary rights have expired or may expire or may not otherwise adequately protect our intellectual property, products and potential products, and if we cannot obtain adequate protection of our intellectual property, products and potential products, we may not be able to successfully market our products and potential products.
Our commercial success will depend, in part, on obtaining and maintaining intellectual property protection for our technologies, products, and potential products. We will only be able to protect our technologies, products, and potential products from unauthorized use by third parties to the extent that valid and enforceable patents cover them, or to the extent that other market exclusionary rights apply.
The patent positions of life sciences companies, like ours, can be highly uncertain and involve complex legal and factual questions for which important legal principles remain unresolved. No consistent policy regarding the breadth of claims allowed in such companies’ patents has emerged to date in the United States. The general patent environment outside the United States also involves significant uncertainty. Accordingly, we cannot predict the breadth of claims that may be allowed or that the scope of these patent rights could provide a sufficient degree of future protection that could permit us to gain or keep our competitive advantage with respect to these products and technology. Additionally, life science companies like ours are often dependent on creating a pipeline of products. We may not be able to develop additional potential products or proprietary technologies that produce commercially viable products or that are themselves patentable.
Our issued patents may be subject to challenge and potential invalidation by third parties and our competitors may develop processes to achieve similar results without infringing on our patents. Changes in either the patent laws or in the interpretations of patent laws in the United States, or in other countries, may diminish the value of our intellectual property. In addition, others may independently develop similar or alternative products and technologies that may be outside the scope of our intellectual property. Should third parties develop alternative methods of regulating nicotine in tobacco or obtain patent rights to similar products or technology without infringing on our intellectual property rights, this may have an adverse effect on our business.
The expiration of a portion of the QPT patent family in 2018 may provide third parties with the freedom to target the QPT gene in the tobacco plant. This could result in experiments to try to reduce nicotine levels in tobacco plants to levels that may satisfy the planned new nicotine reduction regulations coming from the FDA. There can be no assurance about whether any third-parties will or will not be successful in such efforts, how long or short in time such efforts will entail and/or if such efforts will or will not infringe other genes and other intellectual property on which we have continuing patent protection that would need to be used, in combination with QPT, to result in RNC tobacco. If independent researchers or our competitors are able to successfully reduce nicotine levels in tobacco plants without violating our patent protections, our ability to license our technology would be negatively impacted and we would likely face increased competition.
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We also rely on license agreements and trade secrets to protect our technology, products, and potential products, especially where we do not believe patent protection is appropriate or obtainable. Trade secrets, however, are difficult to protect. While we believe that we use reasonable efforts to protect our trade secrets, our own, our licensees’ or our strategic partners’ employees, consultants, contractors or advisors may unintentionally or willfully disclose our information to competitors. We seek to protect this information, in part, through the use of non-disclosure and confidentiality agreements with employees, consultants, advisors, and others. These agreements may be breached, and we may not have adequate remedies for a breach. In addition, we cannot ensure that those agreements will provide adequate protection for our trade secrets, know-how, or other proprietary information, or prevent their unauthorized use or disclosure.
To the extent that consultants or key employees apply technological information independently developed by them or by others to our products and potential products, disputes may arise as to the proprietary rights of the information, which may not be resolved in our favor. Key employees are required to assign all intellectual property rights in their discoveries to us. However, these key employees may terminate their relationship with us, and we cannot preclude them indefinitely from dealing with our competitors. If our trade secrets become known to competitors with greater experience and financial resources, the competitors may copy or use our trade secrets and other proprietary information in the advancement of their products, methods, or technologies. If we were to prosecute a claim that a third party had illegally obtained and was using our trade secrets, it could be expensive and time consuming and the outcome could be unpredictable. In addition, courts outside the United States are sometimes less willing to protect trade secrets than courts in the United States. Moreover, if our competitors independently develop equivalent knowledge, we would lack any contractual claim to this information, and our business could be harmed.
The ability to commercialize our existing and potential products will depend on our ability to sell such products without infringing the patent or proprietary rights of third parties. If we are sued for infringing intellectual property rights of third parties, such litigation could be costly and time consuming and an unfavorable outcome could have a significant adverse effect on our business.
The ability to commercialize our potential products will depend on our ability to sell such products without infringing the patents or other proprietary rights of third parties. Third-party intellectual property rights in our field are complicated, and third-party intellectual property rights in these fields are continuously evolving. While we have conducted searches for such third-party intellectual property rights, we have not performed specific searches for third-party intellectual property rights that may raise freedom-to-operate issues, and we have not obtained legal opinions regarding commercialization of our potential products. As such, there may be existing patents that may affect our ability to commercialize our potential products.
In addition, because patent applications are published up to 18 months after their filing, and because patent applications can take several years to issue, there may be currently pending third-party patent applications and freedom-to-operate issues that are unknown to us, which may later result in issued patents.
If a third-party claims that we infringe on its patents or other proprietary rights, we could face a number of issues that could seriously harm our competitive position, including:
| ● | infringement claims that, with or without merit, can be costly and time consuming to litigate, can delay regulatory authorization processes, and can divert management’s attention from our core business strategy; |
| ● | substantial damages for past infringement which we may have to pay if a court determines that our products or technologies infringe upon a competitor’s patent or other proprietary rights; |
| ● | a court order prohibiting us from commercializing our potential products or technologies unless the holder licenses the patent or other proprietary rights to us, which such holder is not required to do; |
| ● | if a license is available from a holder, we may have to pay substantial royalties or grant cross licenses to our patents or other proprietary rights; and |
| ● | redesigning our process so that it does not infringe the third-party intellectual property, which may not be possible, or which may require substantial time and expense including delays in bringing our potential products to market. |
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Such actions could harm our competitive position and our ability to generate revenue and could result in increased costs.
Our patent applications may not result in issued patents, which may have a material adverse effect on our ability to prevent others from commercially exploiting products similar to ours.
We own or exclusively control many issued patents and pending patent applications. We cannot be certain that these patent applications will issue, in whole or in part, as patents. Patent applications in the United States are maintained in secrecy until the patents are published or are issued. Since publication of discoveries in the scientific or patent literature tends to lag behind actual discoveries by several months, we cannot be certain that we are the first creator of inventions covered by pending patent applications or the first to file patent applications on these inventions. We also cannot be certain that our pending patent applications will result in issued patents or that any of our issued patents will afford protection against a competitor. In addition, patent applications filed in foreign countries are subject to laws, rules and procedures that differ from those of the United States, and thus we cannot be certain that foreign patent applications related to U.S. patents will be issued. Furthermore, if these patent applications issue, some foreign countries provide significantly less effective patent enforcement than in the United States.
The status of patents involves complex legal and factual questions and the breadth of claims allowed is uncertain. Accordingly, we cannot be certain that the patent applications that we or our licensors file will result in patents being issued, or that our patents and any patents that may be issued to us in the near future will afford protection against competitors with similar technology. In addition, patents issued to us may be infringed upon or designed around by others and others may obtain patents that we need to license or design around, either of which would increase costs and may adversely affect our operations.
We license certain patent rights from third-party owners. If such owners do not properly maintain or enforce the patents underlying such licenses, our competitive position and business prospects could be harmed.
We license rights to third-party intellectual property that is necessary or useful for our business, and we may enter into additional licensing agreements in the future. Our success could depend in part on the ability of some of our licensors to obtain, maintain, and enforce patent protection for their intellectual property, in particular, those patents to which we have secured exclusive rights. Our licensors may not successfully prosecute the patent applications to which we are licensed and may in some instances retain rights to the intellectual property that allows them to compete with us. Even if patents are issued with respect to these patent applications, our licensors may fail to maintain these patents, may determine not to pursue litigation against other companies that are infringing these patents, or may pursue such litigation less aggressively than we could. Without protection for the intellectual property we license, other companies might be able to offer substantially identical products for sale, which could adversely affect our competitive business position and harm our business prospects.
Our worldwide exclusive licenses relating to tobacco from NCSU involve multiple patent families and trade secrets. The exclusive rights under the NCSU agreements expire on the date on which the last patent or registered plant variety covered by the subject license expires in the country or countries where such patents or registered plant varieties are in effect. The NCSU licenses relate predominately to issued patents, and our exclusive rights in the NCSU licenses are expected to expire in 2042.
If any of our license agreements or other intellectual property agreements are not effective at preventing others from competing with us and/or using our intellectual property, our business could be adversely affected.
Risks Related to Ownership of Our Common Stock
Nasdaq may delist our common stock from trading on its exchange which could limit investors’ ability to make transactions in our common stock and subject us to additional trading restrictions.
Our common stock is currently listed on the Nasdaq Capital Market (“NASDAQ”). If Nasdaq delists our common stock from trading on its exchange, we could face significant material adverse consequences, including:
| ● | a limited availability of market quotations for our common stock; |
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| ● | reduced liquidity with respect to our securities; |
| ● | a determination that shares of our common stock are “penny stock” which will require brokers trading in our shares to adhere to more stringent rules, possibly resulting in a reduced level of trading activity in the secondary trading market for our shares; |
| ● | a limited amount of news and analyst coverage; and |
| ● | a decreased ability to issue additional common stock or obtain additional financing in the future. |
On November 7, 2023, the Company received a deficiency letter from the Nasdaq Listing Qualifications Department notifying the Company that, for the last 30 consecutive business days, the closing bid price for the Company’s common stock has been below the minimum $1.00 per share required for continued listing on The Nasdaq Capital Market pursuant to Nasdaq Listing Rule 5550(a)(2) (“Rule 5550(a)(2)”). In accordance with Nasdaq Listing Rule 5810(c)(3)(A), the Company has been given 180 calendar days, or until May 5, 2024, to regain compliance with Rule 5550(a)(2). If the Company does not regain compliance with Rule 5550(a)(2) by May 5, 2024, the Company may be afforded a second 180 calendar day period to regain compliance. To qualify, the Company would be required to meet the continued listing requirement for market value of publicly held shares and all other initial listing standards for the Nasdaq Capital Market, except for the minimum bid price requirement. In addition, the Company would be required to provide written notice to Nasdaq of its intent to cure the deficiency during the second compliance period. The Company intends to monitor the closing bid price of its common stock and may, if appropriate, consider implementing available options to regain compliance with the Minimum Bid Price Requirement under the Nasdaq Listing Rules such as a reverse stock split.
On January 24, 2024, the stockholders approved a proposal to amend the Company’s Articles of Incorporation to effect a reverse stock split of the Company’s outstanding common stock at a ratio between 1-for-2 and 1-for-16, to be determined at the discretion of the Board of Directors, for the purpose of complying with the Nasdaq Listing Rules, subject to the Board or Directors’ discretion to abandon such amendment. The Company has not implemented the reverse stock split as of March 25, 2024.
An active trading market for our common stock may not be sustained and you may not be able to resell your shares at or above the price at which you purchased them.
An active trading market for our shares may not be sustained. In the absence of an active trading market for our common stock, shares of common stock may not be able to be resold at or above the purchase price of such shares. Although there can be no assurances, we expect that our common stock will continue to be listed on the NASDAQ. However, even if our common stock continues to be listed on the NASDAQ, there is no assurance that an active market for our common stock will continue in the foreseeable future. There also can be no assurance that we can maintain such listing on the NASDAQ. If we are ever no longer listed on the NASDAQ or other national stock exchange in the future, then it would be more difficult to dispose of shares or to obtain accurate quotations as to the market value of our common stock compared to securities of companies whose shares are traded on national stock exchanges.
Our stock price may be highly volatile and could decline in value.
Our common stock is currently traded on the NASDAQ and the market price for our common stock has been volatile. Further, the market prices for securities in general have been highly volatile and may continue to be highly volatile in the future. The following factors, in addition to other risk factors described in this section, may have a significant impact on the market price of our common stock:
| ● | general economic conditions, including adverse changes in the global financial markets; |
| ● | actual and anticipated fluctuations in our quarterly financial and operating results; |
| ● | developments or disputes concerning our intellectual property or other proprietary rights; |
| ● | introduction of technological innovations or new commercial products by us or our competitors; |
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| ● | issues in manufacturing or distributing our products or potential products; |
| ● | market acceptance of our products or potential products; |
| ● | FDA or other United States or foreign regulatory actions affecting us or our industry; |
| ● | litigation or public concern about the safety of our products or potential products; |
| ● | negative press or publicity regarding us or our common stock; |
| ● | the announcement of litigation against us or the results of on-going litigation; |
| ● | additions or departures of key personnel; |
| ● | third-party sales of large blocks of our common stock or third party short-selling activity; |
| ● | third-party articles regarding us or our securities; |
| ● | pending or future shareholder litigation; |
| ● | sales of our common stock by our executive officers, directors, or significant stockholders; and |
| ● | equity sales by us of our common stock or securities convertible into common stock to fund our operations. |
These and other external factors may cause the market price and demand for our common stock to fluctuate substantially, which may limit or prevent investors from readily selling their shares of common stock and may otherwise negatively affect the liquidity of our common stock. In addition, in the past, when the market price of a stock has been volatile, holders of that stock have instituted securities class action litigation against the company that issued the stock, such as the current class action and derivative lawsuits. Such lawsuits and any future related lawsuits could cause us to incur substantial costs defending the lawsuit and can also divert the time and attention of our management, which would have a negative adverse impact on our business. See the risk factor below entitled: “We are named defendant in certain litigation matters, including federal securities class action lawsuits and derivative complaints; if we are unable to resolve these matters favorably, then our business, operating results and financial condition may be adversely affected.”
We are named defendant in certain litigation matters, including federal securities class action lawsuits and derivative complaints; if we are unable to resolve these matters favorably, then our business, operating results and financial condition may be adversely affected.
We are currently involved in certain litigation matters, including securities class action and derivative litigation. See "Item 3 – Legal Proceedings" included in this Annual Report on Form 10-K. We cannot at this time predict the outcome of these matters or any future litigations matters (whether related or unrelated) or reasonably determine the probability of a material adverse result or reasonably estimate range of potential exposure, if any, that these matters or any future matters might have on us, our business, our financial condition or our results of operations, although such effects, including the cost to defend, any judgements or indemnification obligations, among others, could be materially adverse to us. In addition, in the future, we may need to record litigation reserves with respect to these matters. Further, regardless of how these matters proceed, it could divert our management’s attention and other resources away from our business.
Future sales of our common stock will result in dilution to our common stockholders.
Sales of a substantial number of shares of our common stock in the public market may depress the prevailing market price for our common stock and could impair our ability to raise capital through the future sale of our equity securities. Additionally, if any of the holders of outstanding options or warrants exercise or convert those shares, as applicable, our common stockholders will incur dilution in their relative percentage ownership. The prospect of this possible dilution may also impact the price of our common stock.
31
We do not expect to declare any dividends on our common stock in the foreseeable future.
We have not paid cash dividends to date on our common stock. We currently intend to retain our future earnings, if any, to fund the development and growth of our business, and we do not anticipate paying any cash dividends on our common stock for the foreseeable future. Additionally, the terms of any future debt facilities may preclude us from paying dividends on the common stock. As a result, capital appreciation, if any, of our common stock could be the sole source of gain for the foreseeable future.
Anti-takeover provisions contained in our articles of incorporation and bylaws, as well as provisions of Nevada law, could impair a takeover attempt.
Our amended and restated articles of incorporation and bylaws currently contain provisions that, together with Nevada law, could have the effect of rendering more difficult or discouraging an acquisition deemed undesirable by our board of directors. Our corporate governance documents presently include the following provisions:
| ● | providing for a “staggered” board of directors in which only one-third (1/3) of the directors can be elected in any year; |
| ● | authorizing blank check preferred stock, which could be issued with voting, liquidation, dividend, and other rights superior to our common stock; and |
| ● | limiting the liability of, and providing indemnifications to, our directors and officers. |
These provisions, alone or together, could delay hostile takeovers and changes in control of our Company or changes in our management.
As a Nevada corporation, we also may become subject to the provisions of Nevada Revised Statutes Sections 78.378 through 78.3793, which prohibit an acquirer, under certain circumstances, from voting shares of a corporation’s stock after crossing specific threshold ownership percentages, unless the acquirer obtains the approval of the stockholders of the issuer corporation. The first such threshold is the acquisition of at least one-fifth, but less than one-third of the outstanding voting power of the issuer. We may become subject to the above referenced Statutes if we have 200 or more stockholders of record, at least 100 of whom are residents of the State of Nevada and do business in the State of Nevada directly or through an affiliated corporation.
As a Nevada corporation, we are subject to the provisions of Nevada Revised Statutes Sections 78.411 through 78.444, which prohibit an “interested stockholder” from entering into a combination with the corporation, unless certain conditions are met. An “interested stockholder” is a person who, together with affiliates and associates, beneficially owns (or within the prior two years did own) 10 percent or more of the corporation’s voting stock.
Any provision of our amended and restated articles of incorporation, our bylaws or Nevada law that has the effect of delaying or deterring a change in control of our Company could limit the opportunity for our stockholders to receive a premium for their shares of our common stock and could also affect the price that some investors are willing to pay for our common stock.
Item 1B. Unresolved Staff Comments
None.
32
Item 1C. Cybersecurity
The Company recognizes the critical importance of maintaining the trust and confidence of our customers, clients, business partners and employees. The Board has delegated to the Audit Committee oversight of cybersecurity and other information technology risks affecting the Company. The Audit Committee and senior management are actively involved in oversight of the Company’s risk management program, and cybersecurity represents an important component of the Company’s overall approach to enterprise risk management (“ERM”). In general, the Company seeks to address cybersecurity risks through a comprehensive, cross-functional approach that is focused on preserving the confidentiality, security and availability of the information that the Company collects and stores by identifying, preventing and mitigating cybersecurity threats and effectively responding to cybersecurity incidents when they occur.
Risk Management and Strategy
As one of the critical elements of the Company’s overall ERM approach, the Company’s cybersecurity program is focused on the following key areas:
Collaborative Approach: The Company has implemented a comprehensive, cross-functional approach to identifying, preventing and mitigating cybersecurity threats and incidents, while also implementing controls and procedures that provide for the prompt escalation of certain cybersecurity incidents so that decisions regarding the public disclosure and reporting of such incidents can be made by management in a timely manner.
Technical Safeguards: The Company deploys technical safeguards that are designed to protect the Company’s information systems from cybersecurity threats, including firewalls, intrusion prevention and detection systems, anti-malware functionality and access controls, which are evaluated and improved through vulnerability assessments and cybersecurity threat intelligence.
Third-Party Risk Management: The Company maintains a comprehensive, risk-based approach to identifying and overseeing cybersecurity risks presented by third parties, including vendors, service providers and other external users of the Company’s systems, as well as the systems of third parties that could adversely impact our business in the event of a cybersecurity incident affecting those third-party systems.
Education and Awareness: The Company provides regular, mandatory training for personnel regarding cybersecurity threats as a means to equip the Company’s personnel with effective tools to address cybersecurity threats, and to communicate the Company’s evolving information security policies, standards, processes and practices.
The Company engages a third-party service provider specializing in information technology, which assists with the periodic assessment and testing of the Company’s policies, standards, processes and practices that are designed to address cybersecurity threats and incidents. These efforts include a wide range of activities, including audits, assessments, tabletop exercises, threat modeling, vulnerability testing and other exercises focused on evaluating the effectiveness of our cybersecurity measures and planning.
Governance
The Audit Committee oversees the Company’s ERM process, including the management of risks arising from cybersecurity threats. On an annual basis, the Audit Committee discusses with Senior Management cybersecurity risks, which address a wide range of topics including recent developments, evolving standards, vulnerability assessments, third-party and independent reviews, the threat environment, technological trends and information security considerations arising with respect to the Company’s peers and third parties. As applicable, the Audit Committee also receives prompt and timely information regarding any cybersecurity incident that meets established reporting thresholds, as well as ongoing updates regarding any such incident until it has been addressed.
33
Senior management, in coordination with the Company’s third-party service provider specializing in information technology, works collaboratively across the Company to implement a program designed to protect the Company’s information systems from cybersecurity threats and to promptly respond to any cybersecurity incidents in accordance with the Company’s incident response and recovery plans. Through ongoing communications with the third party service provider, Senior Management monitors the prevention, detection, mitigation and remediation of cybersecurity threats and incidents in real time and report such threats and incidents to the Audit Committee when appropriate.
Cybersecurity threats, including as a result of any previous cybersecurity incidents, have not materially affected or are reasonably likely to affect the Company, including its business strategy, results of operations or financial condition, but we cannot provide assurance that they will not be materially affected in the future by such risks or any future material incidents. For more information on our cybersecurity related risks, see Item 1A Risk Factors in this Annual Report on Form 10-K.
Item 2.Properties.
Our principal executive office and headquarters is located in Mocksville, North Carolina, a leased facility. We previously held our principal executive office and headquarters at leased office space in Buffalo, New York through the end of fiscal 2023.
As of December 31, 2023, we operated four tobacco facilities located in Mocksville, North Carolina and surrounding areas. These locations are comprised of one manufacturing facility (which is also our principal executive office and headquarters) and three leased inventory storage facilities. We believe the facilities we operate and their equipment are effectively utilized, well maintained, generally are in good condition, and will be able to accommodate our capacity needs to meet current and growing levels of demand. We continuously review our anticipated requirements for facilities and, on the basis of that review, may from time to time acquire additional facilities, expand or dispose of existing facilities.
Item 3.Legal Proceedings.
See Note 12 - Commitments and Contingencies – Litigation - to our consolidated financial statements included in this Annual Report for information concerning our on-going litigation. In addition to the lawsuits described in Note 12 to our consolidated financial statements, from time to time we may be involved in claims arising in the ordinary course of business. To our knowledge, other than the cases described in Note 12 to our consolidated financial statements, no material legal proceedings, governmental actions, investigations or claims are currently pending against us or involve us that, in the opinion of our management, could reasonably be expected to have a material adverse effect on our business and financial condition.
Item 4.Mine Safety Disclosures.
Not applicable
PART II
Item 5.Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Our common stock is listed on the Nasdaq Capital Market under the symbol “XXII.” As of March 25, 2024, there were approximately 122 holders of record of our common stock based on the records of our transfer agent. However, because many of our shares of common stock are held by brokers and other institutions on behalf of shareholders, we believe there are considerably more beneficial holders of our common stock than record holders.
34
Dividend Policy
We have not previously and do not plan to declare or pay any dividends on our common stock. Our current policy is to retain all funds and any earnings for use in the operation and expansion of our business. Payment of future dividends, if any, will be at the discretion of our board of directors after taking into account various factors, including current financial condition, operating results and current and anticipated cash needs.
Recent Sales of Unregistered Securities
On November 2, 2023, we executed a licensing agreement (“NCSU License Agreement”) with North Carolina State University (“NCSU”). Pursuant to the terms of the License Agreement, NCSU granted the Company exclusive rights to Patent Rights and Plant Materials (each as defined in the NCSU License Agreement) owned by NCSU which will allow us to develop and commercialize reduced nicotine content tobacco using the latest non-GMO technology. As partial consideration, we issued 183,680 shares of our common stock, equal in value to $100,000, to NCSU (the “Stock Consideration”) calculated using the twenty-day average closing price of the Company’s common stock immediately preceding November 2, 2023. The Stock Consideration was issued in a private placement and was exempt from registration under the Securities Act of 1933, as amended, in reliance on Section 4(a)(2) thereof as a transaction not involving a public offering and/or Rule 506 of Regulation D promulgated thereunder.
On November 28, 2023, we commenced a warrant inducement offering with the holders of our previously outstanding 31,779,654 warrants consisting of: (i) the common stock purchase warrants issued on or about June 22, 2023; (ii) the common stock purchase warrants issued on or about July 10, 2023; (iii) the common stock purchase warrants of issued on or about July 21, 2023; and/or (iv) the common stock purchase warrants issued on or about October 19, 2023 (collectively, the “Existing Warrants”), which Existing Warrants were exercisable for an equal number of shares of common stock at an exercise price of $0.525. We offer the holders of the Existing Warrants an inducement period, whereby we agreed to issue new warrants (the “Inducement Warrants”) to purchase up to a number of shares of common stock equal to 200% of the number of shares of common stock issued pursuant to the exercise by the holders of the Existing Warrants during the Inducement Period, for cash, at a reduced exercise price equal to the Nasdaq Minimum Price (as defined in the as defined in Nasdaq Listing Rule 5635(d)). As a result of the warrant inducement offering, 28,649,654 Existing Warrants were exercised for shares of common stock and 57,299,308 Inducement Warrants were issued. The Inducement Warrants were issued in reliance upon an exemption from registration pursuant to Section 4(a)(2) under the Securities Act of 1933, as amended.
We amended the outstanding Debentures to (i) allow the holders to voluntarily convert the Debentures, in whole or in part, into shares of our common stock (“Voluntary Conversion Option”) on the earlier of (i) June 30, 2024 and (ii) the public announcement of a Fundamental Transaction at a conversion price equal to the lower of (x) $1.00 per share and (y) the closing sale price of our common stock on June 29, 2024 (the “Conversion Price”), and (ii) include a mandatory prepayment of the outstanding principal of the Debentures in an amount equal to 20% of the net cash proceeds of any issuance by us of any of its stock, or other Equity Interests (as defined in the Debentures) or the incurrence or issuance of any indebtedness. The amended Debentures and shares issuable upon conversion of the amended Debentures were issued in a private placement and were exempt from registration under the Securities Act of 1933, as amended, in reliance on Section 4(a)(2) thereof as a transaction not involving a public offering and/or Rule 506 of Regulation D promulgated thereunder.
Issuer Purchases of Equity Securities
None.
35
Shares authorized for issuance under equity compensation plans
On June 16, 2023, the stockholders of 22nd Century Group, Inc. (the “Company”) approved the amendment and restatement of the 22nd Century Group, Inc. 2021 Omnibus Incentive Plan (the “Plan”). The Plan allows for the granting of equity awards to eligible individuals over the life of the Plan, including the issuance of up to 566,667 shares of the Company’s common stock and any remaining shares under the Company’s 2014 Omnibus Incentive Plan pursuant to awards under the Plan. The Plan 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 Plan and the number of shares of common stock to underlie each such award under the Plan. As of December 31, 2023, we had available 606,406 shares remaining for future awards under the Plan.
The following table summarizes the number of shares of common stock to be issued upon exercise of outstanding options and vesting of restricted stock units under the Plan and our prior 2014 Equity Incentive Plan, the weighted-average exercise price of such stock options, and the number of securities available to be issued under the Plan as of December 31, 2023:
|
|
| Number of securities |
| |||||
remaining available for |
| ||||||||
Number of securities to | issuance under equity |
| |||||||
be issued upon exercise | Weighted average | compensation plans |
| ||||||
of outstanding options, | exercise price of | (excluding securities |
| ||||||
and restricted stock units | outstanding options | reflected in column (a)) |
| ||||||
(a) | (b) | (c) |
| ||||||
Equity compensation plans approved by security holders |
| 373,831 | (1) | $ | 26.34 |
| 606,406 | ||
Equity compensation plans not approved by security holders |
| — |
| N/A |
| — | |||
Total |
| 373,831 |
| — |
| 606,406 | (2) | ||
| (1) | Consists of outstanding options of 219,316 and unvested restricted stock units of 154,515. |
| (2) | Consists of shares available for award under the Plan. |
Item 6.[Reserved]
Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations.
This discussion should be read in conjunction with the other sections of this Form 10-K, including “Risk Factors,” and the Financial Statements and notes thereto. The various sections of this discussion contain a number of forward-looking statements, all of which are based on our current expectations and could be affected by the uncertainties and risk factors described throughout this Annual Report on Form 10-K. See “Cautionary Note Regarding Forward-Looking Statements and Risk Factor Summary.” Our actual results may differ materially. For purposes of this Management’s Discussion and Analysis of Financial Condition and Results of Operations, references to the “Company,” “we,” us” or “our” refer to the operations of 22nd Century Group, Inc. and its direct and indirect subsidiaries for the periods described herein.
($ in thousands, except per share data or unless otherwise specified)
36
Executive Overview
| ● | On December 23, 2021, the FDA issued modified risk granted orders for our reduced nicotine cigarettes, VLN® King and VLN® Menthol King. In addition to authorizing the Company to market VLN® cigarettes with the claim, “95% less nicotine”, to clarify the purpose of the brand, the FDA also required the use of the claim, “Helps You Smoke Less.” |
| ● | Commenced pilot market sales in Chicago during the first quarter of 2022 of VLN® King and VLN® Menthol King 95% reduced nicotine content cigarettes, the first and only FDA authorized MRTP designated combustible cigarettes, and subsequently expanded sales and distribution channels throughout 2022 and 2023 to more than 5,000 stores across 26 states. |
| ● | In December 2023, the Company completed the sale of substantially all of the GVB hemp/cannabis business (referred to as the “GVB Divestiture”) to Specialty Acquisition Corporation, exiting the hemp/cannabis market and focusing fully on the Company’s tobacco operations. |
| ● | Appointed Larry Firestone as Chairman and Chief Executive Officer in November 2023, and announced plans for a turnaround in the business, including cost reductions and efforts to reposition the company’s business to focus on its VLN assets and CMO business. |
Tobacco Business Highlights
| ● | Continued a multi-state VLN® rollout strategy, having launched sales in more than 5,000 locations across 26 states at year-end 2023, aimed at penetrating geographies and markets with large adult smoker populations, including those with favorable MRTP state excise tax savings, which can be used toward consumer incentives, distribution support, and additional programming to raise awareness of VLN® products. |
| ● | Initiated agreements with national-scale C-store distribution partners, including Core-Mark/Eby-Brown, McLane and others pending, to facilitate state-wide or multi-state launches of VLN® at hundreds of stores within our target markets in an accelerated timeline. |
| ● | Launched a private label premium cigarette brand, Pinnacle, for sale at one of the nation’s top 10 gas station convenience store chains, comprising almost 1,700 stores in 27 states. |
| ● | Announced expansion into Texas, California and Florida, expected in conjunction with the largest multi-state U.S. C-store chain leveraging these new national scale distribution capabilities. |
| ● | Secured additional retail point of sale placements with regional C-stores, such as Texas based CEFCO, and new regional distribution agreements with Hub, Inc., serving regional Midwestern and tribal accounts, and Chambers & Owen, Inc., serving the upper Midwest. |
| ● | Gained authorization to test VLN® sales at four United States military bases located in California, Arizona and North Carolina, beginning in the second quarter. |
| ● | Launched sales at a top U.S. drugstore chain at approximately 1,200 locations across five states in the third quarter. |
| ● | Poised to benefit from federal, state and international regulatory appetite for banning menthol and mandating reduced nicotine content. The Company has the only FDA-authorized combustible cigarette able to meet the stringent reduced nicotine content product standard under the FDA’s Comprehensive Plan requiring that all cigarettes be made “minimally or non-addictive.” |
| o | Proposed FDA menthol cigarette ban, in final rules status, could leave VLN® Menthol King as the only combustible menthol cigarette on the market, providing a critical off-ramp to help current menthol smokers to smoke less, a final decision is now expected in 2024. |
37
Recent Business Divestiture
On December 22, 2023, we completed the sale of substantially all of the assets of the GVB hemp/cannabis business to Specialty Acquisition Corporation. As a result, we classified the results of operations of the hemp/cannabis segment and disposal group as discontinued operations in the Consolidated Statements of Operations for all periods presented and classified the related assets and liabilities associated with the discontinued operations as held for sale in the Consolidated Balance Sheets as of December 31, 2023 and 2022, respectively. All results and information presented exclude the hemp/cannabis segment and disposal group unless otherwise noted.
Refer to Note 2 “Discontinued Operations and Divestitures” of the Notes to Consolidated Financial Statements contained in Item 15 of this report for additional information about the divestiture of the GVB and hemp/cannabis disposal group.
Financial Overview – Fourth Quarter and Full Year 2023 Results
| ● | Net revenues for the fourth quarter of 2023 were $7,357, a decrease of 26.1% from $9,951 in 2022, primarily driven by a decrease in volumes of filtered cigars. |
| o | Fourth quarter 2023 cartons sold of 823 compared to 1,354 in the comparable prior year period. |
| ● | Net revenues for the full year 2023 were $32,204, a decrease of 20.5% from $40,501 in 2022. |
| ● | Gross profit for the fourth quarter of 2023 was a loss of $7,829 compared to gross loss of $44 in the prior year period. |
| ● | Gross profit for the full year 2023 was a loss of $8,696, compared to a gross profit of $1,847 in 2022. |
| ● | Total operating expenses for the fourth quarter 2023 decreased to $6,403 compared to $10,172 in the prior year quarter driven by: |
| o | Sales, general and administrative expenses decreased to $4,005 driven primarily by a decrease in personnel costs, strategic consulting, and sales and marketing due to our cost savings initiatives. |
| o | Research and development expenses decreased to $493, driven by a decrease in personnel expenses and costs associated with the Company’s research programs. |
| o | Other operating expenses, net was $1,905, primarily reflecting restructuring costs of $1,871, including impairment and legal charges. |
| ● | Operating loss for the fourth quarter 2023 was $14,232, compared to a loss of $10,216 in the prior year period. Operating loss for the full year 2023 was $44,931, compared to a loss of $33,635 in the prior year. |
| ● | Net loss in the fourth quarter of 2023 was $22,068, representing a net loss per share of $0.66 compared with net loss in the fourth quarter of 2022 of $11,114, representing a net loss per share of $0.77. Net loss for the full year 2023 was $54,686, representing a net loss per share of $2.64 compared with net loss for the full year 2022 of $36,553, representing a net loss per share of $2.84. |
| ● | As of December 31, 2023, we had $2,058 in cash and cash equivalents. |
38
Our Financial Results
The following table presents selected financial information derived from our Consolidated Financial Statements, contained in Item 15 of this report, for the periods presented (dollars in thousands, except per share amounts):
| Year Ended | |||||||||||
| December 31 | December 31 | Change | |||||||||
|
| 2023 |
| 2022 | $ | % | ||||||
Revenues, net | $ | 32,204 | $ | 40,501 | (8,297) | (20.5) | ||||||
Cost of goods sold | 40,900 | 38,654 | 2,246 | 5.8 | ||||||||
Gross (loss) profit | (8,696) | 1,847 | (10,543) | NM | ||||||||
Gross (loss) profit as a % of revenues, net | (27.0) | % | 4.6 | % | ||||||||
Operating expenses: | ||||||||||||
Sales, general and administrative ("SG&A") | 31,064 | 32,231 | (1,167) | (3.6) | ||||||||
SG&A as a % of revenues, net | 96.5 | % | 79.6 | % | ||||||||
Research and development ("R&D") | 2,644 | 3,578 | (934) | (26.1) | ||||||||
R&D as a % of revenues, net | 8.2 | % | 8.8 | % | ||||||||
Other operating expenses (income), net ("OOE") | 2,527 | (327) | 2,854 | NM | ||||||||
Total operating expenses | 36,235 | 35,482 | 753 | 2.1 | ||||||||
Operating loss from continuing operations | (44,931) | (33,635) | (11,296) | 33.6 | ||||||||
Operating loss as a % of revenues, net | (139.5) | % | (83.0) | % | ||||||||
Other income (expense): | ||||||||||||
Other income (expense), net | 334 | (366) | 700 | (191.3) | ||||||||
Realized loss on Panacea investment | - | (2,789) | 2,789 | NM | ||||||||
Loss on transfer of promissory note | (895) | - | (895) | NM | ||||||||
Interest income, net | 219 | 313 | (94) | (30.0) | ||||||||
Interest expense | (9,366) | (55) | (9,311) | NM | ||||||||
Total other expense | (9,708) | (2,897) | (6,811) | 235.1 | ||||||||
Loss before income taxes | (54,639) | (36,532) | (18,107) | 49.6 | ||||||||
Provision for income taxes | 47 | 21 | 26 | NM | ||||||||
Net loss from continuing operations | (54,686) | (36,553) | (18,133) | 49.6 | ||||||||
Net loss as a % of revenues, net | (169.8) | % | (90.3) | % | ||||||||
Net loss per common share from continuing operations (basic and diluted)* | $ | (2.64) | $ | (2.84) | 0.20 | (7.04) | ||||||
NM - calculated change not meaningful | ||||||||||||
Fiscal 2023 Compared with Fiscal 2022
Revenue - Sale of products, net
|
| Year Ended | ||||
|
| December 31 | December 31 | |||
|
| 2023 |
| 2022 | ||
Revenues, net | $ | 32,204 | $ | 40,501 | ||
Tobacco revenue was $32,204, a decrease of 20.5% from $40,501 in the prior year period, reflecting lower unit sales as a result of a planned reallocation in production resources during 2023 at the Company’s NASCO facilities away from lower margin filtered cigars to higher margin VLN® and conventional cigarette products. Full year 2023 cartons sold were of 3,459 compared to 5,782 in the comparable prior year period.
39
Gross profit
| Year Ended | |||||||
| December 31 | December 31 | ||||||
|
| 2023 | 2022 | |||||
Gross (loss) profit | $ | (8,696) | $ | 1,847 | ||||
Percent of Revenues, net | (27.0) | % | 4.6 | % | ||||
The decrease in gross profit and gross profit as a percent of revenues, net for the year ended December 31, 2023, compared to the year ended December 31, 2022, was primarily driven by lower volume due to an intentional shift during 2023 in product mix. In connection with evaluation of strategic alternatives and tobacco focused restructuring efforts, during the fourth quarter of 2023, the Company increased the reserve for excess, obsolete or expired leaf inventory by $7,720.
Sales, general and administrative expense
| Changes From Prior Year | |
Compensation and benefits (a) | $ | (2,239) |
Strategic consulting (b) | (393) | |
Sales and marketing (c) | 986 | |
Administrative, public company and other expenses (d) | 274 | |
Legal (e) | 205 | |
Net decrease in SG&A expenses | $ | (1,167) |
(a) Decreases in compensation and benefits primarily resulted from $3,200 benefit of lower equity based compensation expense due to current year headcount reduction and forfeitures, and compared with prior year accelerated vesting of an employee’s outstanding equity awards as part of a termination severance agreement; $218 decrease in severance expenses offset by an increase of $1,179 in personnel costs due to increased headcount during the year compared to the prior year period.
(b) Decrease of strategic consulting due to restructuring efforts and implementation of cost savings initiatives.
(c) Increased sales and marketing related to expansion of VLN®.
(d) Other expenses increased due to $291 of technology expenses, $579 in public company fees, $270 of facilities expense offset by a decrease in insurance expenses of $469 and other of $397.
(e) Increased legal expenses due to regulatory compliance, business development, and contract matters.
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Research and development expense
Changes From Prior Year | |||
Compensation and benefits (a) | $ | (164) | |
Royalty, license and contract costs (b) | (376) | ||
Consulting and professional services (c) | (478) | ||
Other | 84 | ||
Net decrease in R&D expenses | $ | (934) | |
(a) Decreased compensation and benefits primarily related to personnel bonus expense of $255 in the prior year period as compared to $0 in the current year.
(b) Decreased expenses primarily due to a decrease in royalty fees due in the current year period.
(c) Decreased consulting due to an evaluation of strategic opportunities related to our tobacco patent portfolio that occurred in the period year period.
Other operating expenses (income), net
Year Ended | ||||||
December 31, | ||||||
| 2023 |
| 2022 | |||
Restructuring costs: | ||||||
Impairment of intangible assets | $ | 1,375 | $ | 35 | ||
Impairment of fixed assets | 56 | - | ||||
Professional services | 763 | - | ||||
Severance | 221 | - | ||||
Total Restructuring costs (a) | 2,415 | 35 | ||||
Acquisition and transaction costs (b) | 223 | — | ||||
Gain on sale or disposal of property, plant and equipment (c) | (111) | (362) | ||||
Total other operating expenses (income), net | $ | 2,527 | $ | (327) | ||
NM - calculated change not meaningful | ||||||
| (a) | During the second half of 2023, the Company undertook various restructuring activities in an effort to better align its internal organizational structure and costs with its strategy, as well as preserve liquidity. As a result, the Company incurred $2,415 in restructuring costs for the year ended December 31, 2023, which included costs related to employee termination, professional services and consulting, and long-lived asset impairment. |
| (b) | Acquisition and transaction costs primarily relate to professional fees incurred in connection with potential capital markets transactions. |
| (c) | Reflects gain on sale resulting from sale of older manufacturing equipment. |
Refer to Note 18, “Other operating expenses, net,” of the Notes to Consolidated Financial Statements contained in Item 15 of this report for additional information regarding these charges.
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Other income (expense)
| Changes From Prior Year | ||
Other income (expense): | |||
Realized loss on Panacea investment (a) | $ | (2,789) | |
Other income (expense), net (b) | (700) | ||
Loss on transfer of promissory note (c) | 895 | ||
Interest income, net | 94 | ||
Interest expense (d) | 9,311 | ||
Net increase in other expense | $ | 6,811 | |
| (a) | Realized loss on PLSH investment reflects the change in fair value and write-off of our investment in PLSH common stock during the year ended December 31, 2022 of $2,340 and extinguishment of note receivable of $500 less adjusted discount of $51. |
| (b) | Other income (expense), net includes a decrease of $336 of realized losses on short-terms investments and $364 gain on change in fair value of warrant liability. |
| (c) | In connection with the Senior Secured Credit Facility October Amendment, the Company assigned $3,800 PLSH promissory note less unamortized discount of $305, and corresponding pay down of indebtedness on outstanding principal of $600 and redemption of the related warrant liability of $2,000 resulting in loss on sale of financial asset of $895. |
| (d) | Interest expense increased in 2023, as compared to the prior year period, primarily due to the cash interest of $1,104 and non-cash interest of $2,087 recognized from the Senior Secured Credit Facility (of these totals, $366 of interest was allocated to discontinued operations), and additional charges of $5,158 for extinguishment of debt and $557 of derivative liability in connection with the December Amendment. Additionally, interest expense increased as a result of PIK interest of $695 recognized from the Subordinated Note. |
Liquidity and Capital Resources
We have incurred significant losses and negative cash flows from operations since inception and expect to incur additional losses until such time that we can generate significant revenue and profit in our tobacco business. We had negative cash flow from operations of $54,987 for the year ended December 31, 2023 and an accumulated deficit of $378,707 as of December 31, 2023. As of December 31, 2023, we had cash and cash equivalents of $2,058, and working capital of ($6,826) (compared to working capital of $22,079 at December 31, 2022). Given our projected operating requirements and existing cash and cash equivalents, there is substantial doubt about our ability to continue as a going concern through one year following the date that the Consolidated Financial Statements herein are issued.
In response to these conditions, management is currently evaluating different strategies for reducing expenses, as well as pursuing financing strategies which include raising additional funds through the issuance of securities, asset sales, and through arrangements with strategic partners. If capital is not available to the Company when, and in the amounts needed, it could be required to liquidate inventory or assets, cease or curtail operations, seek to negotiate new business deals with our business partners or seek protection under applicable bankruptcy laws or similar state proceedings. There can be no assurance that the Company will be able to raise the capital it needs to continue operations. Accordingly, there is substantial doubt regarding our ability to continue in operations. Management’s plans do not alleviate substantial doubt about the Company’s ability to continue as a going concern through one year following the date that the Consolidated Financial Statements are issued.
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Our cash and short-term investments, and working capital as of December 31, 2023, and 2022, are set forth below:
| December 31 | December 31, | ||||
|
| 2023 |
| 2022 | ||
Cash and cash equivalents | $ | 2,058 | $ | 2,205 | ||
Short-term investment securities | $ | — |
| $ | 18,193 | |
Working capital | $ | (6,826) |
| $ | 22,079 | |
Working Capital
As of December 31, 2023, we had working capital, excluding assets and liabilities held for sale, of approximately ($6,826) compared to working capital of approximately $22,079 as of December 31, 2022, a decrease of $28,905. This decrease in working capital is primarily driven by the decrease in short-term investment securities resulting from cash burn, increase in current portion of long-term debt, and other normal fluctuations from operations in accounts receivable, inventory, accounts payable and accrued expenses.
Summary of Cash Flow
| Year Ended | |||||||
December 31, | Change | |||||||
|
| 2023 |
| 2022 | $ | |||
Cash provided by (used in): | ||||||||
Operating activities | $ | (54,987) | $ | (51,714) | (3,273) | |||
Investing activities |
| 16,816 |
|
| 22,578 | (5,762) | ||
Financing activities |
| 37,209 |
|
| 30,820 | 6,389 | ||
Net change in cash and cash equivalents | $ | (962) |
| $ | 1,684 | |||
Net cash used in operating activities
Cash used in operations increased $3,273 from $51,714 in 2022 to $54,987 in 2023. The primary driver for this increase was higher net loss of $80,974, driven by increased spending in SG&A and R&D both from the acquisition of GVB and acceleration of the launch of VLN®, an increase of $67,866 related to net adjustments to reconcile net loss to cash, and an increase in cash used for working capital components related to operations in the amount of $9,835 for the year ended December 31, 2023, as compared to the year ended December 31, 2022.
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Net cash provided by investing activities
Cash provided by investing activities amounted to $16,816 in 2023 as compared to cash provided by investing activities of $22,578 in 2022. The decrease in cash provided by investing activities of $5,762 was primarily the result of (i) a decrease in net proceeds from short-term investments of $10,338; (ii) $1,188 related to the acquisition of patents, trademarks and property, plant and equipment; and (iii) $126 of proceeds from the sale of property, plant and equipment. These decreased cash outflows were partially offset by an increase in cash inflows of (i) $3,500 of property, plant, and equipment casualty loss insurance proceeds collected in the current year; (ii) $1,043 from the acquisition of RXP in the current year and GVB in the prior year period; (iii) $682 from the investment in Change Agronomy Ltd. in the prior year and (iv) $665 from proceeds from the sale of discontinued operations.
Net cash provided by financing activities
During the year ended December 31, 2023, cash provided by financing activities increased by $6,389 resulting from the net proceeds of $16,048 from issuance of long-term debt, proceeds of $6,016 from issuance of detachable warrants, net proceeds of $3,044 from warrant exercises, net proceeds of $2,563 from issuance of common stock related to the prior ATM facility, increased proceeds of $198 from the issuance of notes payable, and a decrease in other financing of $29. These cash inflows were offset by a decrease in net proceeds of issuance of common stock of $9,605, payments of long-term debt of $9,700, increased note payable payments of $1,759, taxes paid related to net share settlement of RSUs of $271 and $174 of option exercises that occurred in 2022.
Cash demands on operations
As of December 31, 2023, we had approximately $2,058 of cash and cash equivalents. Our principal sources of liquidity are our cash and cash equivalents and cash generated from our tobacco contract manufacturing business and proceeds from debt and equity financing activities, which cash flows provided by financing activities for the year ended December 31, 2023 were $37,209.
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As discussed above, in response to the cash demands on operations, management has implemented programs to evaluate strategic alternatives for the Company’s assets and cost cut initiatives intended to reduce our operating costs to provide additional cash runway. However, our cash, cash equivalents, potential business interruption insurance proceeds, and debt/equity financings, as well as the sustained tobacco contract manufacturing, currently are not forecasted to provide sufficient cash resources or liquidity for a period of twelve months from issuance of these consolidated financial statements.
Senior Secured Credit Facility
On March 3, 2023, the Company entered into that certain Securities Purchase Agreement (the “SPA”) with JGB Partners, LP (“JGB Partners”), JGB Capital, LP (“JGB Capital”) and JGB Capital Offshore Ltd. (“JGB Offshore” and collectively with JGB Partners and JGB Capital, the “Holders”) and JGB Collateral, LLC, as collateral agent for the Holders (the “Agent”) which pursuant to the agreement, the Company sold 5% original issuance discount senior secured debentures with an aggregate principal amount of $21,053. The Debentures bear interest at a rate of 7% per annum, payable monthly in arrears as of the last trading day of each month and on the maturity date. The Debentures mature on March 3, 2026. At the Company’s election, subject to certain conditions, interest can be paid in cash, shares of the Company’s common stock, or a combination thereof. The Debentures are subject to an exit payment equal to 5% of the original principal amount, or $1,053, payable on the maturity date or the date the Debentures are paid in full (the “Exit Payment”). Any time after, March 3, 2024, the Company may irrevocably elect to redeem all of the then outstanding principal amount of the Debentures for cash in an amount equal to the entire outstanding principal balance, including accrued and unpaid interest, the Exit Payment and a prepayment premium in an amount equal to 3% of the outstanding principal balance as of the prepayment date (collectively, the “Prepayment Amount”). Upon the entry into a definitive agreement that would effect a change in control (as defined in the Debentures) of the Company, the Agent may require the Company to prepay the outstanding principal balance in an amount equal to the Prepayment Amount. Commencing on May 1, 2024, at its option, the holder of a Debenture may require the Company to redeem 2% of the original principal amount of the Debentures per calendar month which amount may at the Company’s election, subject to certain exceptions, be paid in cash, shares of the Company’s common stock, or a combination thereof.
The JGB Warrants are exercisable for five years from September 3, 2023, at an exercise price of $19.125 per share, a 50% premium to the VWAP on the closing date, subject, with certain exceptions, to adjustments in the event of stock splits, dividends, subsequent dilutive offerings and certain fundamental transactions. As a result of the June 19, 2023 offering, the Company’s outstanding JGB warrants to purchase up to 333,334 shares of the Company’s common stock for an exercise price of $19.125 per share were automatically adjusted to be $12.828 exercise price for up to 496,960 shares of common stock. There are no further anti-dilution adjustments on such warrants. In connection with the JGB October Amendment, the Company and Holders agreed to exercise the outstanding put provision to redeem 166,667 Warrants for an aggregate put price equal to $2,500.
Following the JGB October and December Amendments (as further described in Note 13 “Debt” of the Notes to Consolidated Financial Statements contained in Item 15 of this report), as of December 31, 2023 the remaining principal loan balance is approximately $10,752, exit fee of $1,052 and remaining $500 of the put price will be due at maturity in March 2026 in accordance with the original terms of the debenture agreements. As of December 31, 2023, the Company has pledged to JGB the $2,000 GVB promissory note and $1,000 assignment of Needle Rock Farms to be applied as principal reduction in 2024.
Omnia Subordinated Note
On March 3, 2023, the Company executed a Subordinated Promissory Note (the “Subordinated Note”) with a principal amount of $2,865 in favor of Omnia Ventures, LP (“Omnia”). The Subordinated Note refinanced the 12% Secured Promissory Note with a principal amount of $1,000 dated as of October 29, 2021 payable to Omnia (the “October Note”) and the 12% Secured Promissory Note with a principal amount of $1,500 dated as of January 14, 2022 payable to Omnia (the “January Note”, and together with the October Note, the “Original Notes”), which were assumed by the Company in connection with the acquisition of GVB Biopharma.
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Under the terms of the Subordinated Note, the Company is obligated to make interest payments in-kind (the “PIK Interest”). The PIK Interest accrues at a rate of 26.5% per annum, payable monthly. The Company is not permitted to prepay all or any portion of the outstanding balance on the Subordinated Note prior to maturity. The maturity date of the Subordinated Note is May 1, 2024.
In connection with the Subordinated Note, the Company issued to Omnia, warrants to purchase up to 45,000 shares of the Company’s common stock. The Omnia Warrants are exercisable for seven years from September 3, 2023, at an exercise price of $12.828 per share subject, with certain exceptions, to adjustments in the event of stock splits, dividends, subsequent dilutive offerings and certain fundamental transactions.
ATM Offering
On March 9, 2023 the Company entered into a Sales Agreement (the “Sales Agreement”) with Cowen and Company, LLC (the “Sales Agent”) under which the Company was previously able issue and sell in a registered offering shares of our common stock having an aggregate offering price of up to $50,000 from time to time through or to the Sales Agent (the “ATM Offering”). The Company paid 3.00% sales commission based on the gross proceeds of the sales price per share of common stock sold. Total net proceeds during the second quarter of 2023 were $2,563. On June 19, 2023, the Company terminated the ATM Program in connection with the June 2023 offering described below.
June 19, 2023 Registered Direct Offering
On June 19, 2023, the Company and certain investors entered into a securities purchase agreement relating to the issuance and sale of shares of approximately $5,300 of shares and warrants, consisting of an aggregate of 747,974 shares of common stock and 747,974 warrants to purchase an equal number of shares, at a purchase price of $7.05 per unit. The net proceeds to the Company from the offering were approximately $4,800.
The warrants were exercisable immediately upon issuance at an exercise price of $7.05 per share of common stock, expire on June 22, 2028 and are subject to adjustment in certain circumstances, including upon any subsequent equity sales at a price per share lower than the then effective exercise price of such warrants, then such exercise price shall be lowered to such price at which the shares were offered.
As part of the offering, the Company entered into a warrant reprice letter and agreed to reduce the exercise price on the previously issued 747,974 warrants owned by the investors participating in the Offering from $30.75 to $7.05 and to add a provision in the warrants that upon any subsequent equity sales at a price per share lower than the then effective exercise price of such warrants, such exercise price shall be lowered to such price at which the shares were offered. As a result of the offerings completed in July 2023, the exercise price on the 1,495,948 warrants was automatically adjusted to $2.42 per share and subsequently adjusted to $0.525 per share in October. All of the outstanding warrants were subsequently exercised in connection with the Warrant Inducement Offering.
The remaining 390,247 previously issued warrants were not repriced and remain at an exercise price of $30.75 on their original terms. On December 7, 2023, the Company was provided notice of irrevocable abandonment of 325,205 warrants.
In addition, as a result of the offering, the Company’s outstanding warrants to purchase up to 333,334 shares of the Company’s common stock for an exercise price of $19.125 per share were automatically adjusted as follows: $12.828 exercise price for up to 496,960 shares of common stock, of which 166,667 were redeemed in October 2023 (see above discussion of amendment and waiver under Senior Secured Credit Facility).
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July 6, 2023 Registered Direct Offering.
On July 6, 2023, the Company and certain investors entered into a securities purchase agreement relating to the issuance and sale of approximately $3,000 of shares and warrants, consisting of an aggregate of 778,634 shares of common stock and 1,557,268 warrants to purchase an equal number of shares, at a purchase price of $3.80 per unit. The warrants are exercisable six months after issuance at an exercise price of $3.80 per share of common stock and expire on January 10, 2029. The net proceeds to the Company from the offering were approximately $2,722. As a result of the subsequent offering completed in July 2023, the exercise price on the 1,557,268 warrants was automatically adjusted to $2.42 per share and subsequently adjusted to $0.525 per share in October. All of the outstanding warrants were subsequently exercised in connection with the Warrant Inducement Offering.
July 19, 2023 Registered Direct Offering.
On July 19, 2023, the Company and certain investors entered into a securities purchase agreement relating to the issuance and sale of approximately $11,700 of shares and warrants, consisting of an aggregate of 4,373,219 shares of common stock and 8,746,438 warrants to purchase an equal number of shares, at a purchase price of $2.67 per unit. The warrants are exercisable immediately at an exercise price of $2.42 per share of common stock and expire five years after issuance. The net proceeds to the Company from the offering were approximately $10,742. As a result of the subsequent offering completed in October 2023, the exercise price on the 8,746,438 warrants was automatically adjusted to $0.525 per share. 8,296,438 of the warrants were subsequently exercised in connection with the Warrant Inducement Offering.
October 2023 Public Offering
On October 17, 2023, the Company entered into a securities purchase agreement with certain investors, pursuant to which the Company agreed to sell and issue, in a registered public offering, (i) an aggregate of 7,600,000 shares of the Company’s common stock, par value $0.00001 per share, (ii) warrants to purchase 20,000,000 shares of common stock (the “Common Warrants”) and (iii) pre-funded warrants to purchase 2,400,000 shares of common stock (the “Pre-Funded Warrants”). The Common Warrants have an exercise price of $0.525, are immediately exercisable and have a term of exercise equal to five years following the original issuance date. The Pre-Funded Warrants have an exercise price of $0.0001, are immediately exercisable and are exercisable at any time after their original issuance until such Pre-Funded Warrants are exercised in full. The shares were offered at a combined public offering price of $0.525 per share and two accompanying Common Warrants. The Pre-Funded Warrants were offered at a combined public offering price of $0.5249 per Pre-Funded Warrant and two accompanying Common Warrants.
In addition, the Company issued the placement agent warrants to purchase up to 1,000,000 shares of common stock (equal to 10% of the aggregate number of shares and Pre-Funded Warrants sold in the offering) at an exercise price of $0.65625, which represents 125% of the public offering price per share and accompanying Common Warrant. The placement agent agreed not to exercise the such warrants until the Company subsequently increases its authorized shares of common stock.
The offering closed on October 19, 2023 with gross proceeds to the Company of approximately $5,250, before deducting the placement agent fees of $367 and other offering expenses payable by the Company of approximately $288. As a result of the offering, the exercise price on 11,799,654 previously outstanding warrants were automatically adjusted from $2.42 per share to $0.525 per share.
The Pre-Funded Warrants were subsequently exercised on a cashless basis in October 2023, resulting in issuance of 2,399,512 shares of common stock. 17,300,000 of the October Warrants were subsequently exercised in connection with the Warrant Inducement Offering.
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Warrant Inducement Offering
On November 28, 2023, the Company commenced a warrant inducement offering with the holders of the Company’s outstanding 31,779,654 warrants consisting of: (i) the common stock purchase warrants of the Company issued on or about June 22, 2023; (ii) the common stock purchase warrants of the Company issued on or about July 10, 2023; (iii) the common stock purchase warrants of the Company issued on or about July 21, 2023; and/or (iv) the common stock purchase warrants of the Company issued on or about October 19, 2023 (collectively, the “Existing Warrants”), which Existing Warrants are exercisable for an equal number of shares of common stock at an exercise price of $0.525. The Company agreed to issue new warrants (the “Inducement Warrants”) to purchase up to a number of shares of common stock equal to 200% of the number of shares of common stock issued pursuant to the exercise by the holders of the Existing Warrants during the inducement period, for cash, at a reduced exercise price equal to the Nasdaq Minimum Price (as defined in the as defined in Nasdaq Listing Rule 5635(d)).
For the period from November 28, 2023 through February 15, 2024, the date of Stockholder Approval, the Company entered into warrant inducement agreements with certain holders of the Existing Warrants to purchase an aggregate of 28,649,654 shares of common stock at a reduced weighted average exercise price of $0.2010. Pursuant to the warrant inducement agreements, the exercising holders of the Existing Warrants received 57,299,308 Inducement Warrants at an exercise price of $0.1765 and the Company received aggregate gross proceeds of approximately $5,757 from the exercise of the Existing Warrants.
Outstanding Warrants
As of March 25, 2024, we had the following warrants outstanding:
# of warrants outstanding | Exercise price | Expiration date | |||||
July 2022 RDO warrants | 65,042 | $ | 30.75 | July 25, 2027 | |||
Senior Secured Credit Facility - JGB | 330,294 | $ | 12.828 | September 3, 2028 | |||
Subordinated Note - Omnia | 45,000 | $ | 12.828 | September 3, 2030 | |||
July 19, 2023 RDO warrants | 450,000 | $ | 0.1765 | July 20, 2028 | |||
October 2023 CMPO warrants | 2,700,000 | $ | 0.1765 | October 19, 2028 | |||
Inducement warrants | 57,299,308 | $ | 0.1765 | February 15, 2029 | |||
60,889,644 | |||||||
Impact of Recently Issued Accounting Standards
In the normal course of business, we evaluate all new accounting pronouncements issued by the Financial Accounting Standards Board (“FASB”), SEC, or other authoritative accounting bodies to determine the potential impact they may have on our Consolidated Financial Statements. Refer to Note 1 “Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements contained in Item 15 of this report for additional information about these recently issued accounting standards and their potential impact on our financial condition or results of operations.
Critical Accounting Estimates
Management’s discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with GAAP. We make estimates and assumptions in the preparation of our consolidated financial statements that affect the reported amounts of assets and liabilities, revenue and expenses and related disclosures of contingent assets and liabilities. We base our estimates and judgments upon historical experience and other factors that are believed to be reasonable under the circumstances. Changes in estimates or assumptions could result in a material adjustment to the consolidated financial statements.
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We have identified several critical accounting estimates. An accounting estimate is considered critical if both: (a) the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment involved, and (b) the impact of changes in the estimates and assumptions have had or are reasonably likely to have a material effect on the consolidated financial statements. This listing is not a comprehensive list of all of our accounting policies. For further information regarding the application of these and other accounting policies, see Note 1 “Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements contained in Item 15 of this report.
Inventories
Inventories are measured on a first-in, first-out basis at the lower of cost or net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The valuation of inventory requires us to estimate obsolete or excess inventory, as well as inventory that is not of saleable quality.
Historically, our adjustments or write-off charges recorded against inventory have been adequate to cover our losses. However, variations in methods or assumptions could have a material impact on our results. Additionally, if our demand forecasts for specific products is greater than actual demand and we fail to reduce manufacturing output accordingly, we could be required to record additional inventory write-down or expense a greater amount of overhead costs, which would negatively impact our gross profit and net income.
Valuation of Long-Lived Assets
We make assumptions in establishing the carrying value, fair value and, if applicable, the estimated lives of our intangible and other long-lived assets. Intangible assets determined to have an indefinite useful life are not amortized. Instead, these assets are evaluated for impairment on an annual basis on December 1, the measurement date, and whenever events or business conditions change that could indicate that the asset is impaired. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset (asset group) may not be recoverable.
Evaluation of indefinite-lived intangible assets for impairment
Our indefinite-lived intangible assets include the MSA, cigarette brand predicate and trademarks. We perform an annual impairment review of our indefinite-lived intangible assets on December 1, the measurement date, unless events occur that trigger the need for an interim impairment review. We have the option to first assess qualitative factors in determining whether it is more-likely-than-not that an indefinite-lived intangible asset is impaired. If we elect not to use this option, or we determine that it is more-likely-than-not that the asset is impaired, we perform a quantitative assessment that requires us to estimate the fair value of each indefinite-lived intangible asset and compare that amount to its carrying value. Impairment, if any, is based on the excess of the carrying value over the fair value of these assets.
For our indefinite-lived intangible assets, we performed a qualitative evaluation and considered factors such as current and future sales projections, strategic objectives, future market and economic conditions, competition, and federal and state regulations. We determined as of December 1, 2023, it is more likely than not that that the assets are not impaired.
Evaluation of long-lived assets for impairment
When impairment indicators exist, we determine if the carrying value of the long-lived asset(s) including, but not limited to, PP&E, right-of-use lease assets, and definite-lived intangible asset(s) exceeds the related undiscounted future cash flows. In cases where the carrying value exceeds the undiscounted future cash flows, the carrying value is written down to fair value. Fair value is generally determined using a discounted cash flow analysis. When it is determined that the useful life of an asset (asset group) is shorter than the originally estimated life, and there are sufficient cash flows to support the carrying value of the asset (asset group), we accelerate the rate of depreciation/amortization in order to fully depreciate/amortize the asset over its shorter useful life.
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Estimation of the cash flows and useful lives of long-lived assets and definite-lived intangible assets requires significant management judgment. Events could occur that would materially affect our estimates and assumptions. Unforeseen changes, such as the loss of one or more significant customers, technology obsolescence, or significant manufacturing disruption, among other factors, could substantially alter the assumptions regarding the ability to realize the return of our investment in long-lived assets, definite-lived intangible assets or their estimated useful lives.
For our long-lived assets, we determined that impairment indicators occurred during the fourth quarter of 2023 in connection with ongoing evaluation of our tobacco strategy and restructuring efforts and concluded that certain definite-lived intangible assets, including patents, were impaired due to obsolescence or abandonment in the amount of $1,375. No other long-lived assets were concluded to be non-recoverable based on undiscounted cash flow analysis performed.
Detachable Warrants
Warrants issued pursuant to debt or equity offerings that the Company may be required to redeem through payment of cash or other assets outside its control are classified as liabilities and therefore measured at fair value. The Company uses a Monte Carlo valuation model to estimate fair value at each issuance and period-end date. The key assumptions used in the model are the expected future volatility in the price of the Company’s shares and the expected life of the warrants.
Embedded Derivatives – Conversion Option
Our December Amendment to the Senior Secured Credit Facility contained an embedded derivative conversion option. The Company evaluates each debt agreement to determine whether any embedded features require bifurcation from the debt host in accordance with ASC 815, Derivatives and Hedging ("ASC 815"). If the embedded feature requires bifurcation from its debt host, the Company will account for it as either a derivative liability or as a derivative in equity. The Company uses valuation models to estimate the fair value of the embedded derivatives. For the valuation to record the debt and embedded derivative related to the conversion option at fair value, the Company uses a binomial lattice model at inception and on subsequent valuation dates. This model incorporates inputs such as the stock price of the Company, risk-free interest rate, the effective debt yield and expected volatility. Certain inputs involve unobservable inputs and are classified as level 3 of the fair value hierarchy (see Note 9, Fair Value Measurement to our Consolidated Financial Statements included elsewhere in Item 15 of this Annual Report). The sensitivity of the fair value calculation to these methods, assumptions, and estimates included could create materially different results under different conditions or using different assumptions.
Off-Balance Sheet Arrangement
We do not have any off-balance sheet arrangements as defined by Item 303(a)(4) of Regulation S-K.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Not required for smaller reporting companies.
Item 8.Financial Statements and Supplementary Data.
The required financial statements and the notes thereto are contained in a separate section of this Form 10-K beginning with the page following Item 15 (Exhibits and Financial Statement Schedules) and are incorporated by reference into this Item 8.
Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
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Item 9A.Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Based on this evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this Annual Report on Form 10-K to ensure information required to be disclosed in the reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time period specified in the SEC’s rules and forms. These disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed by us in the reports we file or submit is accumulated and communicated to management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control - Integrated Framework (2013), our management concluded that our internal control over financial reporting was effective as of December 31, 2023.
Our system of internal control over financial reporting was designed to provide reasonable assurance regarding the preparation and fair presentation of published financial statements in accordance with accounting principles generally accepted in the United States. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance and may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
This Annual Report on Form 10-K does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting due to a permanent exemption for smaller reporting companies.
Changes in Internal Controls over Financial Reporting
There was no change in our internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) during the quarter ended December 31, 2023 that has materially affected, or is reasonably likely to materially affect our internal control over financial reporting.
Item 9B.Other Information.
Item 9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspection
Not applicable.
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PART III
Item 10.Directors, Executive Officers and Corporate Governance.
Information concerning our executive officers, directors and corporate governance is incorporated herein by reference to our definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Form 10-K with respect to its 2024 Annual Meeting of Stockholders.
Code of Business Conduct and Corporate Ethics
Our Board of Directors has long maintained a Code of Ethics that applies to all our directors, officers, and employees. A copy of our Code of Ethics is available on our website at http://www.xxiicentury.com. We intend to satisfy any disclosure requirements pursuant to Item 5.05 of Form 8-K regarding any amendment to, or waiver from, certain provisions of the Code of Ethics by posting such information on our website.
Item 11.Executive Compensation.
Information is incorporated herein by reference to our definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Form 10-K with respect to its 2024 Annual Meeting of Stockholders.
Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Information is incorporated herein by reference to our definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Form 10-K with respect to its 2024 Annual Meeting of Stockholders.
Item 13.Certain Relationships and Related Transactions, and Director Independence.
Information is incorporated herein by reference to our definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Form 10-K with respect to its 2024 Annual Meeting of Stockholders.
Item 14.Principal Accounting Fees and Services.
Information is incorporated herein by reference to our definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Form 10-K with respect to its 2024 Annual Meeting of Stockholders.
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PART IV
Item 15.Exhibits and Financial Statement Schedules.
| (a) | (1) Financial Statements |
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| Page |
Report of Independent Registered Public Accounting Firm (PCAOB ID 0 |
| F-1 |
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|
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Consolidated Financial Statements: |
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| F-4 | |
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Consolidated Statements of Operations and Comprehensive Loss |
| F-5 |
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| F-6 | |
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| F-7 | |
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| F-8–51 |
| (a) | (2) Financial Statement Schedules |
Financial statement schedules have been omitted because they are not required.
| (b) | Exhibits |
Exhibits required by Item 601 of Regulation S-K are listed in the Exhibit Index below following the Financial Statements, which are incorporated herein by this reference.
53
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and the Board of Directors of 22nd Century Group, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of 22nd Century Group, Inc. and subsidiaries (the Company) as of December 31, 2023 and 2022, the related consolidated statements of operations and comprehensive loss, changes in shareholders' equity and cash flows for each of the two years in the period ended December 31, 2023, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2023 and 2022, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
Going Concern
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has incurred significant losses and negative cash flows from operations since inception and expects to incur additional losses until such time that it can generate significant revenue and profit in its tobacco business. Further, the Company has negative working capital and a shareholders’ deficit as of December 31, 2023. This raises substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters also are described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
F-1
Debt related accounting, classification, and valuation
Critical Audit Matter description
As discussed in Note 1 and 13 of the consolidated financial statements, during the year ended December 31, 2023, prior to the amendments described in Note 13, the Company entered into a senior secured credit facility, which consisted of a three-year debenture with a principal amount of $21,053 (as defined in Note 13) and a $2,865 subordinated promissory note (the “Subordinated Note). The Debentures were issued at a 5% original issuance discount and are subject to a 5% exit payment. In connection with the issuance with the Debentures and the Subordinated Note, the Company issued warrants to purchase common stock (“Detachable Warrants")
The Debenture, Subordinated Note, and Detachable Warrants included various terms that required evaluation at the issuance date. Further, a portion of the Detachable Warrants met the criteria for equity classification (Note 10), while a portion are treated as liabilities (Note 9) due to holder put features applicable to only a portion of the warrants issued. The fair value of both classes of warrants was determined at the date of issuance and recorded as a debt discount. The liability classified warrants were subsequently adjusted to fair value at the end of each reporting period.
We identified the accounting for the terms of the Debentures (prior to amendments), Subordinated Note, and Detachable Warrants as well as the valuation and classification of the same as a critical audit matter. Auditing the accounting for these was especially challenging due to the inherent complexity of the agreements and the related valuation models. Auditing these elements required an increased level of audit effort, including the involvement of professionals with specialized skill and knowledge.
How the Critical Audit Matter was addressed in the Audit
Addressing the matter involved performing subjective procedures and evaluating audit evidence in connection with forming our overall opinion on the financial statements. The primary procedures we performed include: Inspecting the underlying agreements and ensuring appropriate application of the relevant accounting literature to the terms of the Debentures and Subordinated Note; evaluating the appropriateness of the fair value and classification of the Detachable Warrants; and utilizing personnel with specialized skill and knowledge in valuation to assist in assessing the fair value determined.
Debt extinguishment, conversion option and fair value measurement
Critical Audit Matter description
During the year ended December 31, 2023, the Company amended the Debentures (as defined in Note 13) with its lenders. The terms of the amendments are described in Note 13. For each amendment, the Company was required to evaluate troubled debt restructuring applicability and debt modification versus extinguishment analysis. Neither qualified as a troubled debt restructuring and the first was a modification while the second was extinguishment, primarily resulting from the addition of conversion feature. Further, the conversion feature did require bifurcation from the debt host. Therefore, both the conversion feature (Note 9) and the Debentures post-extinguishment were subject to fair market measurement. The derivative liability is subsequently adjusted to fair value at the end of each reporting period.
We identified the accounting for the amended terms as well as the valuations related to the conversion option and Debentures post extinguishment as a critical audit matter. Auditing the accounting for these items was especially challenging due to the inherent complexity of the agreements and the related valuation models. Auditing these elements required an increased level of audit effort, including the involvement of professionals with specialized skill and knowledge.
How the Critical Audit Matter was addressed in the Audit
Addressing the matter involved performing subjective procedures and evaluating audit evidence in connection with forming our overall opinion on the financial statements. The primary procedures we performed include: Inspecting the underlying agreements and ensuring appropriate application of the relevant accounting literature to the terms of the amended Debentures; evaluating the appropriateness of the fair value for the bifurcated conversion option derivative and the amended Debentures post-extinguishment utilizing personnel with specialized skill and knowledge in valuation to assist in assessing the fair values determined.
F-2
Discontinued Operations
Critical Audit Matter description
As discussed in Notes 1, and 2 of the consolidated financial statements, during the year ended December 31, 2023, the Company divested substantially all of its assets in the GVB hemp/cannabis business and recorded impairment charges. As a result of the agreement management determined the hemp/cannabis disposal group has met the requirements to be presented as held for sale and discontinued operations for all periods presented. The Company has not segregated the statement of cash flows.
We identified the reporting of discontinued operations and the impairment charges as a critical audit matter, which required extensive effort and a higher degree of auditor judgement.
How the Critical Audit Matter was addressed in the audit
Addressing the matter involved performing subjective procedures and evaluating audit evidence in connection with forming our overall opinion on the financial statements. The primary procedures we performed include: assessed management’s conclusion regarding discontinued operations treatment, obtained and read the related agreements and compared the terms of that agreement to the identification of the assets and liabilities included in the disposal group, reviewed management assumptions and judgment for determining historical numbers related to discontinued operations, reviewed and recomputed the loss on disposal of discontinued operations and related income tax benefit, and assessed the completeness and accuracy of the presentation and disclosures.
/s/ | |
We have served as the Company’s auditor since 2011. | |
March 28, 2024 |
F-3
22nd CENTURY GROUP, INC. AND SUBSIDIARIES | |
CONSOLIDATED BALANCE SHEETS | |
(amounts in thousands, except share and per-share data) | |
December 31, | December 31, | |||||
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ASSETS |
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Current assets: |
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Cash and cash equivalents | $ | | $ | | ||
Short-term investment securities |
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Accounts receivable, net |
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Inventories |
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Insurance recoveries |
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GVB promissory note |
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Prepaid expenses and other current assets |
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Current assets of discontinued operations held for sale |
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Total current assets |
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Property, plant and equipment, net |
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Operating lease right-of-use assets, net |
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Intangible assets, net |
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Other assets | |
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Noncurrent assets of discontinued operations held for sale | — | | ||||
Total assets | $ | | $ | | ||
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LIABILITIES AND SHAREHOLDERS' EQUITY |
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Current liabilities: |
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Notes and loans payable - current | $ | | $ | | ||
Current portion of long-term debt | | — | ||||
Operating lease obligations |
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Accounts payable |
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Accrued expenses |
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Accrued litigation |
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Accrued payroll |
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Accrued excise taxes and fees |
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Deferred income | | | ||||
Other current liabilities |
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Current liabilities of discontinued operations held for sale |
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Total current liabilities |
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Long-term liabilities: |
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Operating lease obligations |
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Long-term debt | | — | ||||
Other long-term liabilities | | | ||||
Noncurrent liabilities of discontinued operations held for sale | — | | ||||
Total liabilities | | | ||||
Commitments and contingencies (Note 12) |
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Shareholders' equity (deficit) |
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Preferred stock, $ |
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Common stock, $ |
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Capital stock and : |
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Common stock, par value | — | — | ||||
Capital in excess of par value |
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Accumulated other comprehensive loss |
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Accumulated deficit |
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Total shareholders' equity (deficit) |
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Total liabilities and shareholders’ equity (deficit) | $ | | $ | | ||
See accompanying notes to consolidated financial statements.
F-4
22nd CENTURY GROUP, INC. AND SUBSIDIARIES | |
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (amounts in thousands, except per-share data) | |
Year Ended | |||||
December 31, | |||||
2023 |
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Revenues, net | $ | | $ | | |
Cost of goods sold |
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Gross (loss) profit |
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Operating expenses: |
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Sales, general and administrative |
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Research and development |
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