22nd CENTURY GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

~~September 30, 2019 with Comparative Figures at December 31, 2018~~(Unaudited)

($ in thousands)

September 30, December 31,
2019 2018
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 617,783 $ 604,925
Short-term investment securities 43,101,178 55,748,939
Accounts receivable, net 773,968 871,293
Inventory, net 2,384,130 3,043,949
Prepaid expenses and other assets 872,905 928,420
Total current assets 47,749,964 61,197,526

Property, plant and equipment:
Machinery and equipment, net 3,241,344 3,260,748
Operating leases right-of-use assets, net 655,193 -
3,896,537 3,260,748

Other assets:
Intangible assets, net 8,535,711 9,751,504
Investment 1,682,048 3,092,358
Total other assets 10,217,759 12,843,862

Total assets $ 61,864,260 $ 77,302,136

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Notes payable $ 576,736 $ 689,148
Operating lease obligations 217,013 -
Accounts payable 1,646,780 2,574,840
Accrued expenses 1,796,186 1,826,481
Accrued severance 196,274 -
Deferred income 594,339 83,075
Total current liabilities 5,027,328 5,173,544

Long-term liabilities:
Notes payable 589,359 848,217
Operating lease obligations 438,181 -
Accrued severance 499,388 -
Total liabilities 6,554,256 6,021,761

Commitments and contingencies (Note 9) - -

Shareholders' equity
10,000,000 preferred shares, $.00001 par value
300,000,000 common shares, $.00001 par value
Capital stock issued and outstanding:
125,772,581 common shares (124,642,593 at December 31, 2018) 1,258 1,246
Capital in excess of par 174,689,019 170,392,249
Accumulated other comprehensive income 114,322 21,363
Accumulated deficit (119,494,595 ) (99,134,483 )
Total shareholders' equity 55,310,004 71,280,375

Total liabilities and shareholders' equity $ 61,864,260 $ 77,302,136


	June 30,		December 31,
	2020		2019
ASSETS
Current Assets:
Cash and cash equivalents	$	844	$	485
Short-term investment securities		28,103		38,477
Accounts receivable, net		999		867
Inventory, net		2,769		2,266
Prepaid expenses and other assets		3,580		648
Total current assets		36,295		42,743
Property, plant and equipment:
Machinery and equipment, net		2,849		3,120
Operating leases right-of-use assets, net		651		602
Total property, plant and equipment		3,500		3,722
Other assets:
Intangible assets, net		8,239		8,494
Investments		7,372		8,403
Convertible note		5,732		5,589
Total other assets		21,343		22,486

Total assets	$	61,138	$	68,951

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Notes payable	$	2,247	$	581
Operating lease obligations		333		220
Accounts payable		1,019		1,997
Accrued expenses		2,235		2,619
Accrued severance		487		359
Deferred income		—		5
Total current liabilities		6,321		5,781
Long-term liabilities:
Notes payable		292		292
Operating lease obligations		318		382
Severance Obligations		342		446
Total long-term liabilities		952		1,120
Commitments and contingencies (Note 11)
Shareholders' equity
10,000,000 preferred shares, $.00001 par value
300,000,000 common shares, $.00001 par value
Capital stock issued and outstanding:
138,854,193 common shares (138,362,809 at December 31, 2019)
Common stock value		1		1
Capital in excess of par value		188,591		187,735
Accumulated other comprehensive (loss) income		52		7
Accumulated deficit		(134,779)		(125,693)
Total shareholders' equity		53,865		62,050
Total liabilities and shareholders’ equity	$	61,138	$	68,951

See accompanying notes to consolidated financial statements.

Table of Contents

22nd CENTURY GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE ~~(LOSS) INCOME~~LOSS

~~Three Months Ended September 30,~~(Unaudited)

~~(unaudited)~~($ in thousands except per-share data)


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2020		2019		2020		2019
Revenue:
Sale of products, net	$	6,435	$	5,815	$	13,493	$	12,109
Cost of goods sold (exclusive of depreciation shown separately below):
Products		6,234		5,901		13,005		12,298
Gross profit (loss)		201		(86)		488		(189)
Operating expenses:
Research and development		957		1,674		1,770		2,914
Research and development - MRTP		4		313		154		1,524
Sales, general and administrative		3,501		2,586		6,640		5,060
Impairment of intangible assets		146		—		146		—
Depreciation		157		147		313		282
Amortization		189		223		361		438
Total operating expenses		4,954		4,943		9,384		10,218
Operating loss		(4,753)		(5,029)		(8,896)		(10,407)
Other income (expense):
Unrealized gain (loss) on investments		312		(1,424)		(133)		1,549
Impairment of stock warrant		(1,062)		—		(1,062)		—
Realized gain (loss) on short-term investment securities		3		72		—		56
Litigation settlement		—		(1,891)		—		(1,891)
Gain on the sale of machinery and equipment		—		—		—		87
Interest income, net		462		243		1,074		515
Interest expense		(19)		(13)		(31)		(24)
Total other income (expense)		(304)		(3,013)		(152)		292
Loss before income taxes		(5,057)		(8,042)		(9,048)		(10,115)
Income taxes		—		—		38		—
Net loss	$	(5,057)	$	(8,042)	$	(9,086)	$	(10,115)
Other comprehensive income (loss):
Unrealized gain (loss) on short-term investment securities		241		89		45		236
Reclassification of gain to net loss		(3)		(72)		—		(56)
Other comprehensive income (loss)		238		17		45		180
Comprehensive loss	$	(4,819)	$	(8,025)	$	(9,041)	$	(9,935)

Net loss per common share - basic and diluted	$	(0.04)	$	(0.06)	$	(0.07)	$	(0.08)
Weighted average common shares outstanding - basic and diluted (in thousands)		138,854		124,662		138,732		124,653

2019 2018
Revenue:
Sale of products, net $ 6,461,914 $ 6,260,158

Cost of goods sold (exclusive of depreciation shown separately below):
Products 6,482,982 6,109,209

Gross (loss) profit (21,068 ) 150,949

Operating expenses:
Research and development (including equity-based compensation of $57,911 and $140,692, respectively) 1,992,687 4,009,808
Sales, general and administrative (including equity-based compensation of $1,382,314 and $332,141, respectively) 4,059,005 1,997,958
Impairment 1,142,349 -
Depreciation 157,654 132,846
Amortization 232,753 219,171
7,584,448 6,359,783

Operating loss (7,605,516 ) (6,208,834 )

Other income (expense):
Unrealized (loss) gain on investment (2,959,898 ) 3,923,156
Realized gain on investments - 8,345,880
Realized gain (loss) on short-term investment securities 90,489 (6,272 )
Interest income, net 242,003 255,155
Interest expense (12,795 ) (4,431 )
(2,640,201 ) 12,513,488

(Loss) income before income taxes (10,245,717 ) 6,304,654

Income taxes - -
Net (loss) income $ (10,245,717 ) $ 6,304,654
Other comprehensive (loss) income:
Unrealized gain on short-term investment securities 3,032 33,386
Reclassification of (gains) losses to net (loss) income (90,489 ) 6,272
(87,457 ) 39,658

Comprehensive (loss) income $ (10,333,174 ) $ 6,344,312

Net (loss) income per common share - basic $ (0.08 ) $ 0.05
Net (loss) income per common share - diluted $ (0.08 ) $ 0.04

Common shares used in basic net (loss) income per share calculation 125,420,277 124,376,061
Common shares used in diluted net (loss) income per share calculation 125,420,277 144,382,479

See accompanying notes to consolidated financial statements.

Table of Contents

22nd CENTURY GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF ~~OPERATIONS~~CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

($ in thousands except share data)


	Three and Six Months Ended June 30, 2020
						Accumulated
	Common	Par Value		Capital in		Other				Total
	Shares	of Common		Excess of		Comprehensive		Accumulated		Shareholders’
	Outstanding	Shares		Par Value		Income		Deficit		Equity
Balance at December 31, 2019	138,362,809	$	1	$	187,735	$	7	$	(125,693)	$	62,050
Stock issued in connection with RSU vesting	491,384		—		—		—		—		—
Equity-based compensation	—		—		480		—		—		480
Unrealized gain (loss) on short-term investment securities	—		—		—		(196)		—		(196)
Reclassification of losses (gains) to net loss	—		—		—		3		—		3
Net loss	—		—		—		—		(4,029)		(4,029)
Balance at March 31, 2020	138,854,193	$	1	$	188,215	$	(186)	$	(129,722)	$	58,308
Equity-based compensation	—		—		376		—		—		376
Unrealized gain (loss) on short-term investment securities	—		—		—		241		—		241
Reclassification of losses (gains) to net loss	—		—		—		(3)		—		(3)
Net loss	—		—		—		—		(5,057)		(5,057)
Balance at June 30, 2020	138,854,193	$	1	$	188,591	$	52	$	(134,779)	$	53,865


	Three and Six Months Ended June 30, 2019
						Accumulated
	Common	Par Value		Capital in		Other				Total
	Shares	of Common		Excess of		Comprehensive		Accumulated		Shareholders’
	Outstanding	Shares		Par Value		Income		Deficit		Equity
Balance at December 31, 2018	124,642,593	$	1	$	170,392	$	21	$	(99,134)	$	71,280
Stock issued in connection with option exercises	17,407		1		—		—		—		1
Equity-based compensation	—		—		449		—		—		449
Unrealized gain (loss) on short-term investment securities	—		—		—		147		—		147
Reclassification of losses (gains) to net loss	—		—		—		16		—		16
Net loss	—		—		—		—		(2,073)		(2,073)
Balance at March 31, 2019	124,660,000	$	2	$	170,841	$	184	$	(101,207)	$	69,820
Stock issued in connection with option exercises	13,936		—		—		—		—		—
Equity-based compensation	—		—		517		—		—		517
Unrealized gain (loss) on short-term investment securities	—		—		—		89		—		89
Reclassification of losses (gains) to net loss	—		—		—		(72)		—		(72)
Net loss	—		—		—		—		(8,042)		(8,042)
Balance at June 30, 2019	124,673,936	$	2	$	171,358	$	201	$	(109,249)	$	62,312

See accompanying notes to consolidated financial statements.

Table of Contents

22nd CENTURY GROUP, INC. AND ~~COMPREHENSIVE (LOSS) INCOME~~SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

~~Nine Months Ended September 30,~~(Unaudited)

~~(unaudited)~~($ in thousands)


	Six Months Ended
	June 30,
	2020		2019
Cash flows from operating activities:
Net loss	$	(9,086)	$	(10,115)
Adjustments to reconcile net loss to cash used in operating activities:
Impairment of intangible assets		146		—
Impairment of stock warrant		1,062		—
Amortization and depreciation		549		602
Amortization of license fees		125		119
Amortization of ROU Asset		151		106
Unrealized (gain) loss on investment		133		(1,549)
Realized (gain) loss on short-term investment securities		—		(56)
Litigation settlement		—		1,891
Gain on the sale of machinery and equipment		—		(87)
Accretion of non cash interest expense		13		21
Accretion of interest on Panacea investment		(306)		—
Equity-based employee compensation expense		856		966
(Increase) decrease in assets:
Accounts receivable		(132)		(39)
Inventory		(503)		112
Prepaid expenses and other assets		(2,934)		(345)
Increase (decrease) in liabilities:		��
Operating lease obligations		(149)		(107)
Accounts payable		(1,033)		(610)
Accrued expenses		(384)		340
Accrued severance		24		—
Deferred income		(5)		7
Net cash provided by (used in) operating activities		(11,473)		(8,744)
Cash flows from investing activities:
Acquisition of patents and trademarks		(198)		(244)
Acquisition of machinery and equipment		(42)		(398)
Proceeds from the sale of machinery and equipment		—		166
Sales and maturities of short-term investment securities		19,272		18,287
Purchase of short-term investment securities		(8,853)		(8,397)
Net cash provided by (used in) investing activities		10,179		9,414
Cash flows from financing activities:
Payment on note payable		(542)		(400)
Proceeds from note payable issuance		2,195		—
Proceeds from SBA loan		1,183		—
Repayment of SBA loan		(1,183)		—
Net cash provided by (used in) financing activities		1,653		(400)
Net increase (decrease) in cash and cash equivalents		359		270
Cash and cash equivalents - beginning of period		485		605
Cash and cash equivalents - end of period	$	844	$	875

Supplemental disclosures of cash flow information:
Net cash paid for:
Cash paid during the period for interest	$	6	$	3
Non-cash transactions:
Patent and trademark additions included in accounts payable	$	54	$	198
Machinery and equipment additions included in accounts payable	$	—	$	58
Right-of-use assets and corresponding operating lease obligations	$	198	$	814
Legal settlement included in accrued expenses	$	—	$	1,891

2019 2018
Revenue:
Sale of products, net $ 18,570,541 $ 19,291,110

Cost of goods sold (exclusive of depreciation shown separately below):
Products 18,780,819 18,906,869

Gross (loss) profit (210,278 ) 384,241

Operating expenses:
Research and development (including equity-based compensation of $228,185 and $1,705,422, respectively) 6,430,738 11,307,984
Sales, general and administrative (including equity-based compensation of $2,177,696 and $1,013,515, respectively) 9,119,090 6,348,059
Impairment 1,142,349 -
Depreciation 439,955 388,668
Amortization 671,105 557,648
17,803,237 18,602,359

Operating loss (18,013,515 ) (18,218,118 )

Other income (expense):
Unrealized (loss) gain on investments (1,410,310 ) 10,070,244
Realized gain on investments - 8,345,880
Realized gain (loss) on short-term investment securities 146,382 (48,461 )
Litigation expense (1,890,900 ) -
Gain on the sale of machinery and equipment 87,351 -
Warrant liability gain - net - 48,711
Interest income, net 757,429 758,665
Interest expense (36,550 ) (4,431 )
(2,346,598 ) 19,170,608

(Loss) income before income taxes (20,360,113 ) 952,490

Income taxes - -

Net (loss) income $ (20,360,113 ) $ 952,490
Other comprehensive income:
Unrealized gain (loss) on short-term investment securities 239,341 (36,987 )
Reclassification of (gains) losses to net (loss) income (146,382 ) 48,461
92,959 11,474

Comprehensive (loss) income $ (20,267,154 ) $ 963,964

Net (loss) income per common share - basic $ (0.16 ) $ 0.01
Net (loss) income per common share - diluted $ (0.16 ) $ 0.01

Common shares used in basic net (loss) income per share calculation 124,911,837 124,237,003
Common shares used in diluted net (loss) income per share calculation 124,911,837 144,243,421

See accompanying notes to consolidated financial statements.

Table of Contents

22nd CENTURY GROUP, INC. AND SUBSIDIARIES

~~CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY~~

~~(unaudited)~~

Three and Nine Months Ended September 30, 2019
Accumulated
Common Par Value Capital in Other
Shares of Common Excess of Comprehensive Accumulated Shareholders'
Outstanding Shares Par Value Income Deficit Equity
Balance at December 31, 2018 124,642,593 $ 1,246 $ 170,392,249 $ 21,363 $ (99,134,483 ) $ 71,280,375

Stock issued in connection with option exercises 17,407 1 (1 ) - - -

Equity-based compensation - - 448,905 - - 448,905

Unrealized gain on short-term investment securities - - - 146,899 - 146,899

Reclassification of losses to net loss - - - 16,021 - 16,021

Net loss - - - (2,072,713 ) (2,072,713 )

Balance at March 31, 2019 124,660,000 1,247 $ 170,841,153 184,283 (101,207,196 ) 69,819,487

Stock issued in connection with option exercises 13,936 - - - - -

Equity-based compensation - - 516,752 - - 516,752

Unrealized gain on short-term investment securities - - - 89,410 - 89,410

Reclassification of gains to net loss - - - (71,914 ) - (71,914 )

Net loss - - - - (8,041,682 ) (8,041,682 )

Balance at June 30, 2019 124,673,936 1,247 171,357,905 201,779 (109,248,878 ) 62,312,053

Stock issued in connection with option exercises 8,645 - - - - -

Equity-based compensation 100,000 1 1,440,224 - - 1,440,225

Stock issued in connection with litigation expense 990,000 10 1,890,890 - - 1,890,900

Unrealized gain on short-term investment securities - - - 3,032 - 3,032

Reclassification of gains to net loss - - - (90,489 ) - (90,489 )

Net loss - - - - (10,245,717 ) (10,245,717 )

Balance at September 30, 2019 125,772,581 $ 1,258 $ 174,689,019 $ 114,322 $ (119,494,595 ) $ 55,310,004

Three and Nine Months Ended September 30, 2018
Accumulated
Common Par Value Capital in Other
Shares of Common Excess of Comprehensive Accumulated Shareholders'
Outstanding Shares Par Value Loss Deficit Equity
Balance at December 31, 2017 123,569,367 $ 1,236 $ 166,592,536 $ - $ (91,167,572 ) $ 75,426,200

Stock issued in connection with warrant exercises 426,180 4 (4 ) - - -

Stock issued in connection with option exercises 315,540 3 217,497 - - 217,500

Equity-based compensation - - 563,876 - - 563,876

Net income - - - - 1,386,488 1,386,488

Balance at March 31, 2018 124,311,087 1,243 167,373,905 - (89,781,084 ) 77,594,064

Equity-based compensation - - 1,682,228 - - 1,682,228

Unrealized loss on short-term investment securities - - - (28,184 ) - (28,184 )

Reclassification of losses to net loss - - - - - -

Net loss - - - (6,738,652 ) (6,738,652 )

Balance at June 30, 2018 124,311,087 1,243 169,056,133 (28,184 ) (96,519,736 ) 72,509,456

Stock issued in connection with warrant exercises 63,832 1 (1 ) - - -

Stock issued in connection with option exercises 26,549 - - - - -

Equity-based compensation - - 472,833 - - 472,833

Unrealized loss on short-term investment securities - - - - - -

Reclassification of warrant liability to capital in excess of par - - 167,779 - - 167,779

Unrealized gain on short-term investment securities - - - 39,658 - 39,658

Net income - - - - 6,304,654 6,304,654

Balance at September 30, 2018 124,401,468 $ 1,244 $ 169,696,744 $ 11,474 $ (90,215,082 ) $ 79,494,380

~~See accompanying notes to consolidated financial statements.~~

~~22nd CENTURY GROUP, INC. AND SUBSIDIARIES~~

~~CONSOLIDATED STATEMENTS OF CASH FLOWS~~

~~Nine Months Ended September 30,~~

~~(unaudited)~~

2019 2018
Cash flows from operating activities:
Net (loss) income $ (20,360,113 ) $ 952,490
Adjustments to reconcile net (loss) income to cash used in operating activities:
Impairment 1,142,349 -
Amortization and depreciation 932,182 856,931
Amortization of license fees 178,877 89,385
Lease expense 159,082 -
Severance expense 720,838
Unrealized loss (gain) on investment 1,410,310 (10,070,244 )
Realized gain on the sale of investments - (8,345,880 )
Realized (gain) loss on short-term investment securities (146,382 ) 48,461
Litigation Expense 1,890,900 -
Gain on the sale of machinery and equipment (87,351 ) -
Warrant liability gain - net - (48,711 )
Accretion of interest on notes payable and accrued severance 33,347 4,431
Equity-based compensation 2,405,881 2,718,937
Inventory write-off 881,588 -
Decrease in inventory reserves - (35,000 )
(Increase) decrease in assets:
Accounts receivable 97,325 20,841
Inventory (221,767 ) (12,730 )
Prepaid expenses and other assets 55,515 (533,282 )
Increase (decrease) in liabilities:
Operating lease obligations (159,082 ) -
Accounts payable (1,082,216 ) 1,420,417
Accrued expenses (30,295) (85,325 )
Accrued severance (29,793 ) -
Deferred income 511,264 457,660
Net cash used in operating activities (11,697,541 ) (12,561,619 )
Cash flows from investing activities:
Acquisition of patents and trademarks (443,504 ) (318,773 )
Acquisition of machinery and equipment (499,350 ) (365,349 )
Proceeds from the sale of machinery and equipment 166,150 -
Proceeds from the sale of investments - 13,051,503
Sales and maturities of short-term investment securities 15,966,007 30,465,534
Purchase of short-term investment securities (3,078,904 ) (32,889,120 )
Net cash provided by investing activities 12,110,399 9,943,795
Cash flows from financing activities:
Payment on note payable (400,000 ) (500,000 )
Proceeds from exercise of stock options - 217,500
Net cash used in financing activities (400,000 ) (282,500 )
Net increase (decrease) in cash and cash equivalents 12,858 (2,900,324 )
Cash and cash equivalents - beginning of period 604,925 3,659,534
Cash and cash equivalents - end of period $ 617,783 $ 759,210

Supplemental disclosures of cash flow information:
Net cash paid for:
Cash paid during the period for interest $ 3,203 $ -
Cash paid during the period for income taxes $ - $ -
Non-cash transactions:
Patent and trademark additions included in accounts payable $ 154,157 $ 338,212
Machinery and equipment additions included in accounts payable $ - $ 13,873
Right-of-use assets and corresponding operating lease obligations $ 814,275 $ -
License acquired with note payable $ - $ 1,175,226
Reclassification of warrant liability to capital in excess of par $ - $ 167,779
Common stock issued in connection with litigation expense $ 1,890,900 $ -

~~See accompanying notes to consolidated financial statements.~~

~~22nd CENTURY GROUP, INC. AND SUBSIDIARIES~~

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

~~September~~June 30, ~~2019~~2020

~~(unaudited)~~(Unaudited)

Amounts in thousands, except for per-share data

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

Basis of Presentation - The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments consisting of normal recurring accruals considered necessary for a fair and non-misleading presentation of the financial statements have been included.

Operating results for the ~~nine~~six months ended ~~September~~June 30, ~~2019~~2020 are not necessarily indicative of the results that may be expected for the year ending December 31, ~~2019.~~2020. The balance sheet as of December 31, ~~2018~~2019 has been derived from the audited consolidated financial statements at that date but does not include all the information and footnotes required by GAAP for complete financial statements.

These interim consolidated financial statements should be read in conjunction with the December 31, ~~2018~~2019 audited consolidated financial statements and the notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, ~~2018,~~2019, as filed with the Securities and Exchange Commission on March ~~6, 2019.~~11, 2020.

Principles of Consolidation - The accompanying consolidated financial statements include the accounts of 22nd Century Group, Inc. (“22nd Century Group”), its ~~three~~3 wholly-owned subsidiaries, 22nd Century Limited, LLC (“22nd Century Ltd”), NASCO Products, LLC (“NASCO”), and Botanical Genetics, LLC (“Botanical Genetics”), and ~~two~~2 wholly-owned subsidiaries of 22nd Century Ltd, Goodrich Tobacco Company, LLC (“Goodrich Tobacco”) and Heracles Pharmaceuticals, LLC (“Heracles Pharma”) (collectively, “the Company”). All intercompany accounts and transactions have been eliminated.

Nature of Business --22nd Century ~~Ltd~~Group, Inc. is a plant biotechnology company specializing in technology that allows (i) for the level of nicotine and other nicotinic alkaloids in tobacco plants to be ~~decreased~~altered through genetic engineering and modern plant breeding and (ii) the levels of cannabinoids in hemp plants to be decreased or increased through genetic engineering and modern plant breeding. Goodrich Tobacco and Heracles Pharma are business units for the Company’s potential modified risk tobacco products. NASCO is a federally licensed tobacco products manufacturer, a subsequent participating member under the tobacco Master Settlement Agreement (“MSA”) between the tobacco industry and the settling states under the MSA and operates the Company’s tobacco products manufacturing business in North Carolina. Botanical Genetics is a wholly-owned subsidiary of 22nd Century Group ~~and was incorporated to facilitate the original investment in Anandia Laboratories, Inc., more fully described in Note 4, and~~that performs research and development related to the Company’s hemp business.

Reclassifications-Certain items in the ~~2018~~2019 financial statements have been reclassified to conform to the ~~2019~~2020 classification. During the ~~third~~second quarter of ~~2019,~~2020, the Company ~~combined sales~~broke out research and ~~marketing expenses with general~~development expense into 2 lines: (i) Research and ~~administrative expenses to create a single line item~~development and (ii) Research and development—MRTP in the operating expense section of the Company’s Consolidated Statements of Operations and Comprehensive ~~(Loss) Income titled sales, general and administrative expenses.~~Loss. The comparative classifications for ~~2018~~2019 have been reclassified to conform to the new presentation.

COVID-19 Pandemic – The COVID-19 pandemic has caused some disruption to our business and poses a risk to our future business, including delays by third party providers of goods or services to our business, interruptions to our sales, research and development, and administrative activities, and disruptions to our manufacturing operations. Similarly, state or federal authorities may also be affected in their capacity or capability to operate as normal and may impact the timeline of product authorizations which may disrupt our business plans.

~~Preferred stock authorized~~ - ~~The Company is authorized to issue “blank check” preferred stock, which could be issued~~Our Williamsville, NY corporate re-opened in June and our R&D laboratory in Buffalo, NY re-opened in May and are currently operating under strict safety protocols in accordance with ~~voting, liquidation, dividend~~New York State’s reopening guidelines. These protocols include physical distancing, mandatory face coverings, disinfection of surfaces, and other ~~rights superior~~health and safety measures. We continue to encourage remote work arrangements by any and all employees where job duties permit. Although our laboratory in Buffalo reopened

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in May, some of our external research and development partners were either closed or operating on a modified or limited schedule during the height of the pandemic. The temporary closure of our laboratory and the interruption to our ~~common stock. No preferred shares~~workflow related to COVID-19 have impacted our internal and external laboratory research operations. Our executive leadership team and staff are continuously monitoring this ever-evolving situation and its impacts on our business.

Our NASCO production facility in North Carolina remains open, having been classified as an essential business as it is part of the supply chain for grocery stores and convenience stores. Despite the pandemic, we have been ~~issued.~~able to fulfill sales orders in a timely manner. The safety and well-being of our employees remains a top priority and we to continue monitor and operate in line with local, state, and federal safety guidelines. An outbreak at our production facility, or disruption in our supply chain, could cause us to slow or temporarily cease our manufacturing operations.

We will continue to monitor the local, state and federal guidance regarding our business practices.

~~Concentration~~Use of ~~Credit Risk~~Estimates- ~~Financial instruments~~The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that ~~potentially subject~~affect the ~~Company to concentration~~reported amounts of ~~credit risk consist~~assets and liabilities and disclosure of cash accounts in financial institutions. Although the cash accounts exceed the federally insured deposit amount, management does not anticipate nonperformance by the financial institutions. Management reviews the financial viability of these institutions on a periodic basis.

~~Cash~~contingent assets and ~~cash equivalents~~~~- The Company considers all highly liquid investments with maturities of three months or less~~liabilities at the date of ~~acquisition to be~~the financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates.

Fair Value of Financial Instruments- The Company’s financial instruments include cash ~~equivalents. However, the Company has elected to classify money market mutual funds related to its short-term investment portfolio as short-term investment securities. Cash~~ and cash equivalents, ~~are stated at cost, which approximates fair value.~~

~~Short-term investment securities~~~~- The Company’s~~ short-term investment securities, accounts receivable, investments, a convertible note receivable, accounts payable, accrued expenses, and notes payable. Other than for cash equivalents, short-term investment securities, certain investments, and convertible note receivable, fair value is assumed to approximate carrying values for these financial instruments, since they are ~~classified~~short term in nature, they are receivable or payable on demand, or had stated interest rates that approximate the interest rates available to the Company as of the reporting date. The determination of the fair value of cash equivalents, short-term investment securities, investments, and convertible note receivable are discussed in Note 6.

Investments- Under ASU 2016-01, equity securities are recorded at fair value, with changes in fair value recorded through the statement of operations. Equity securities without a readily determinable market value are carried at cost less impairment, adjusted for observable price changes in orderly transactions for an identical or similar investment of the same issuer. The Company considers debt instruments as available-for-sale securities, and consist of money market funds, corporate bonds, U.S. government agency bonds, U.S. treasury securities, and commercial paper with maturities greater than three months at the time of acquisition. The Company’s short-term investment securities are carried at fair value within current assets on the Company’s Consolidated Balance Sheets. The Company views its available-for-sale securities as available for use in current operations regardless of the stated maturity date of the security. The Company’s investment policy states that all investment securities must have a maximum maturity of twenty-four (24) months or less and the maximum weighted maturity of the investment securities must not exceed twelve (12) months. All the Company’s short-term investment securities are fixed-income debt instruments, and accordingly, all unrealized gains and losses incurred on the short-term investment securities (the adjustment to fair value) are recorded in other comprehensive income or loss on the Company’s Consolidated Statements of Operations and Comprehensive ~~(Loss) Income. Realized gains~~Loss.

Stock Based Compensation - The Company uses a fair-value based method to determine compensation for all arrangements under which Company employees and ~~losses~~others receive shares, restricted stock units or options to purchase common shares of the Company. Stock based compensation expense is recorded over the requisite service period based on ~~short-term investment securities~~estimates of probability and time of achieving milestones and vesting. For accounting purposes, the shares will be considered issued and outstanding upon vesting or risks of forfeiture expiring.

Income Taxes-For interim income tax reporting, due to a full valuation allowance on net deferred tax assets, no income tax expense or benefit is recorded unless it is an unusual or infrequently occurring item. The tax effects of unusual or infrequently occurring items, including changes in judgment about valuation allowances and effects of changes in tax laws or rates, are ~~recorded~~reported in the ~~other income (expense) portion~~interim period in which they occur.

Table of ~~the Company’s Consolidated Statements of Operations and Comprehensive (Loss) Income. Interest is recorded on the accrual basis and presented net of investment related fees in interest income.~~Contents

~~Accounts receivable~~NOTE 2. -~~The Company periodically reviews aged account balances for collectability. The Company established an allowance for doubtful accounts of $0 at both September 30, 2019 and December 31, 2018~~. INVENTORY
~~Inventory~~ - Inventories are valued at the lower of historical cost or net realizable value. Cost is determined using an average cost method for tobacco leaf inventory and raw materials inventory and standard cost is primarily used for finished goods inventory. Inventories are evaluated to determine whether any amounts are not recoverable based on slow moving or obsolete condition and are written off or reserved as appropriate. During the third quarter of 2019, the Company wrote off tobacco inventory with a cost of $881,588 and this cost in included in research and development expenses on the Company’s Consolidated Statement of Operations and Comprehensive (Loss) Income. Inventories at ~~September~~June 30, ~~2019~~2020 and December 31, ~~2018~~2019 consisted of the following:

September 30, December 31,
2019 2018


June 30,

December 31,


2020

2019
Inventory - tobacco leaf $ 812,206 $ 1,556,581

$
1,191

$
1,178
Inventory - finished goods

Cigarettes and filtered cigars 111,945 156,702

212

106
Inventory - raw materials

Cigarette and filtered cigar components 1,559,979 1,430,666

1,466

1,082
2,484,130 3,143,949

Less: inventory reserve 100,000 100,000

(100)

(100)

$ 2,384,130 $ 3,043,949

$
2,769

$
2,266

NOTE 3. - MACHINERY AND EQUIPMENT
Machinery and equipment - ~~Machinery~~at June 30, 2020 and ~~equipment are recorded at their acquisition cost~~December 31, 2019 consisted of the following:

June 30,

December 31,


Useful Life

2020

2019
Cigarette manufacturing equipment

3 or 10 years

$
4,896

$
4,870
Office furniture, fixtures and equipment

5 Years

162

152
Laboratory equipment

5 Years

125

125
Leasehold improvements

6 Years

263

257

Less: accumulated depreciation



(2,597)

(2,284)
Machinery and equipment, net



$
2,849

$
3,120

Depreciation expense was $157 and ~~depreciated on a straight-line basis over their estimated useful lives ranging from 3 to 10 years.~~$313 for the three and six months ended June 30, 2020, respectively ($147 and $282 for the three and six months ended June 30, 2019, respectively).

NOTE 4. - RIGHT-OF-USE ASSETS, LEASE OBLIGATIONS, AND OTHER LEASES
~~Right-of-use assets~~ - On January 1, 2019, the Company adopted ASU 2016-02, Subtopic ASC 842, Leases (the “new guidance”) and elected to use the practical expedient which allowed the Company to carry forward the historical lease classifications of the existing leases as of adoption. Our lessee right of use (ROU) assets represent our right to use an underlying asset and our lease liabilities represent our obligation to make lease payments.
The Company leases a manufacturing facility and warehouse in North Carolina, a corporate office space in Williamsville, New York, and a laboratory space in Buffalo, New York. The ROU assets and lease liabilities for these operating leases are recognized as of the commencement date at the net present value of the fixed minimum lease payments for the lease term. The discount rate used is the interest rate implicit in the lease, if available, or the Company’s incremental borrowing rate which is determined using a base line rate plus an applicable spread.
The following table summarizes the Company’s discount rate and remaining lease terms:

Weighted average remaining lease term in years

2.4

Weighted average discount rate

4.8
%

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Future minimum lease payments as of June 30, 2020 are as follows:

2020

$
173
2021

324
2022

92
2023

88
2024

15
Total lease payments

692
Less: imputed interest

(41)
Total

$
651

NOTE 5. – INVESTMENTS & CONVERTIBLE NOTE RECEIVABLE
Investment in Panacea Life Sciences, Inc.
On December 3, 2019, the Company entered into a securities purchase agreement with Panacea Life Sciences, Inc. (“Panacea”) for $13,297 in exchange for a 15.8% ownership interest. The Company’s investment consists of 3 instruments: shares of Series B preferred stock (“preferred stock”); a convertible note receivable; and a warrant (“stock warrant”) to purchase additional shares of Series B preferred stock, to obtain 51% ownership of Panacea, at an exercise price of $2.344 per share. The convertible note receivable has a term of five years, bears interest of 10% per annum, and can be converted to shares of Series B preferred stock at the Company’s discretion. The preferred stock carries an annual 10% cumulative dividend, compounded annually, and has an implicit put option after the fifth anniversary date so long that the stock warrants have not been exercised. The stock warrant may be exercised at any time after the fifth anniversary date and would be accelerated if Panacea achieves certain sales targets for two consecutive years. The Series B preferred stock also has equity preferences in the event of a liquidation, sale, or transfer of Panacea assets.
The convertible note receivable and the preferred stock investment are considered available for sale debt securities with a private company that is not traded in active markets. Since observable price quotations were not available at acquisition, fair value was estimated based on cost less an appropriate discount upon acquisition. The discount of each instrument is accreted into interest income over the respective term as shown within the Company’s Consolidated Statements of Operations and Comprehensive Loss. See Note 6 for additional information on these fair value measurements. The stock warrant was recorded at its cost basis in accordance with the practical expedient under ASU 2016-01.
In accordance with ASC 326-30-35 and ASC 321-35-3, credit loss risk of available-for-sale securities and impairment risk of investments recorded at cost should be evaluated if negative indicators are present. During the first six months of 2020, the cannabidiol (CBD) industry has experienced an overall decline due to increased competition, FDA regulation uncertainty, and continued uncertainty from COVID-19—all relevant indicators for the valuation of our Panacea investment. Based on our assessment, we determined that no credit loss existed for the available-for-sale debt security instruments as of June 30, 2020. As such, we concluded that the recorded value aligns with the expected cash flows of the instruments.
However, we determined that the recorded cost basis of the stock warrant exceeded its fair value due to the negative macroeconomic indicators mentioned above. As such, the Company recognized an impairment charge of $1,062 during the three and six months ended June 30, 2020.
Investment in Aurora Cannabis, Inc.
The Company has an investment in Aurora Cannabis Inc. (“Aurora”) stock warrants that are considered equity securities under ASC 321 – Investments – Equity Securities and a derivative instrument under ASC 815 – Derivatives and Hedging. The stock warrants are not designated as a ~~result has~~hedging instrument, and in accordance with ASC 815, the Company’s investment in stock warrants are recorded ~~Right-to-use~~at fair value with changes in fair value recorded to unrealized gain/loss as shown within the Company’s Consolidated Statements of Operations and Comprehensive Loss. See Note 6 for additional information on the fair value measurements.

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The carrying value of the Company’s investments at June 30, 2020 and December 31, 2019 consisted of the following:

June 30,

December 31,

2020

2019
Aurora stock warrants

$
540

$
673
Panacea preferred stock

5,029

4,865
Panacea stock warrant

1,803

2,865
Total Investments

$
7,372

$
8,403
Convertible Note Receivable

$
5,732

$
5,589

NOTE 6. – FAIR VALUE MEASUREMENTS AND SHORT-TERM INVESTMENTS
FASB ASC 820 - “Fair Value Measurements and Disclosures” establishes a valuation hierarchy for disclosure of the inputs to valuation used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows:
● Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities;
● Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument; and
● Level 3 inputs are unobservable inputs based on the Company’s own assumptions used to measure assets and liabilities at fair value.
A financial asset’s or a financial liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.
The following table presents information about our assets and ~~corresponding Lease obligations~~liabilities measured at fair value as ~~more fully discussed~~of June 30, 2020 and December 31, 2019, and indicates the fair value hierarchy of the valuation techniques the Company utilized to determine such fair value:

Fair Value

June 30, 2020


Level 1

Level 2

Level 3

Total
Assets








Short-term investment securities:








Money market funds

$
1,123

$
—

$
—

$
1,123
Corporate bonds

—

26,980

—

26,980
Total short-term investment securities

$
1,123

$
26,980

$
—

$
28,103

Investment - Aurora stock warrants

$
—

$
—

$
540

$
540
Investment - Panacea preferred stock

$
—

$
—

$
5,029

$
5,029
Convertible note receivable

$
—

$
—

$
5,732

$
5,732

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Fair Value

December 31, 2019


Level 1

Level 2

Level 3

Total
Assets








Short-term investment securities:








Money market funds

$
12,146

$
—

$
—

$
12,146
Corporate bonds

—

26,331

—

26,331
Total short-term investment securities

$
12,146

$
26,331

$
—

$
38,477

Investment - Aurora stock warrants

$
—

$
—

$
673

$
673
Investment - Panacea preferred stock

$
—

$
—

$
4,865

$
4,865
Convertible note receivable

$
—

$
—

$
5,589

$
5,589

Money market mutual funds are valued at their daily closing price as reported by the fund. Money market mutual funds held by the Company are open-end mutual funds that are registered with the SEC that generally transact at a stable $1.00 Net Asset Value (“NAV”) representing its estimated fair value. On a daily basis the fund’s NAV is determined by the fund based on the amortized cost of the funds underlying investments.
Corporate bonds are valued using pricing models maximizing the use of observable inputs for similar securities.
The investment in ~~Note 3.~~the Aurora stock (ACB) warrants is measured at fair value using the Black-Scholes pricing model and is classified within Level 3 of the valuation hierarchy. The unobservable input is an estimated volatility factor of 141% and 83% at June 30, 2020 and December 31, 2019, respectively. Therefore, changes in market volatility will impact the fair value measurement of our ACB investment.
A 20% increase or decrease in the volatility factor used at June 30, 2020 would have the impact of increasing or decreasing the fair value measurement of the stock warrants by approximately $175. A 20% increase or decrease in the volatility factor used at December 31, 2019 would have the impact of increasing or decreasing the fair value measurement of the stock warrants by approximately $260.
9
The Panacea convertible note receivable and the preferred stock investment are considered available-for-sale debt securities with a private company that is not traded in active markets. Since observable price quotations were not available, fair value was estimated based on cost less an appropriate discount upon acquisition. The discount of each instrument is accreted into interest income over the respective term and will adjust the amortized cost basis of the investments.

The following table sets forth a summary of the changes in fair value of the Company’s Level 3 investments for the quarter ended June 30, 2020:

Fair Value at December 31, 2019

$
11,128
Unrealized loss as a result of change in fair value

(133)
Accretion of interest on Panacea Investment

306
Fair Value at June 30, 2020

$
11,301

12

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The following tables set forth a summary of the Company’s available-for-sale debt securities from amortized cost basis to fair value as of June 30, 2020 and December 31, 2019:

Available for Sale Debt Securities

June 30, 2020

Amortized

Gross

Gross

Cost

Unrealized

Unrealized

Fair


Basis

Gains

Losses

Value
Corporate bonds

$
26,928

$
140

$
(88)

$
26,980
Convertible note receivable

5,732

—

—

5,732
Investment - Panacea preferred stock

5,029

—

—

5,029

$
37,689

$
140

$
(88)

$
37,741

Available for Sale Debt Securities

December 31, 2019

Amortized

Gross

Gross

Cost

Unrealized

Unrealized

Fair


Basis

Gains

Losses

Value
Corporate bonds

$
26,324

$
64

$
(57)

$
26,331
Convertible note receivable

5,589

—

—

5,589
Investment - Panacea preferred stock

4,865

—

—

4,865

$
36,778

$
64

$
(57)

$
36,785

The following table sets forth a summary of the Company’s available-for-sale securities from amortized cost basis and fair value by contractual maturity as of June 30, 2020 and December 31, 2019:

Available for Sale Debt Securities

June 30, 2020

December 31, 2019

Amortized

Amortized


Cost Basis

Fair Value

Cost Basis

Fair Value
Due in one year or less

$
18,796

$
18,796

$
16,823

$
16,851
Due after one year through five years

18,893

18,945

9,501

9,480
Due in five years

—

—

10,454

10,454

$
37,689

$
37,741

$
36,778

$
36,785

~~Intangible Assets~~NOTE 7. - INTANGIBLE ASSETS
Intangible assets are recorded at cost and consist primarily of (1) expenditures incurred with third-parties related to the processing of patent claims and trademarks with government authorities, as well as costs to acquire patent rights from third-parties, (2) license fees paid for third-party intellectual property, (3) costs to become a signatory under the tobacco MSA, and (4) license fees paid to acquire a predicate cigarette product. The amounts capitalized relate to intellectual property that the Company owns or to which it has exclusive rights. The Company’s intellectual property capitalized costs are amortized using the straight-line method over the remaining statutory life of the granted patent assets in each of the Company’s patent families, which have estimated expiration dates ranging from ~~2019~~2020 to 2036. Periodic maintenance or renewal fees are expensed as incurred. Annual minimum license fees are charged to expense. License fees paid for third-party intellectual property are amortized on a straight-line basis over the last to expire patents, which patent expiration dates are expected to range from ~~2019~~2020 through 2036. The Company believes costs associated with becoming a signatory to the MSA and acquiring a predicate cigarette product have an indefinite life and as such, no amortization is taken.

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Total intangible assets at ~~September~~June 30, ~~2019~~2020 and December 31, ~~2018~~2019 consisted of the following:

June 30,

December 31,


2020

2019
Intangible assets, net




Patent and trademark costs

$
5,512

$
5,712
Less: accumulated amortization and impairment

(2,774)

(2,839)
Patent and trademark costs, net

2,738

2,873

License fees

3,776

3,777
Less: accumulated amortization

(827)

(708)
License fees, net

2,949

3,069

MSA signatory costs

2,202

2,202


License fee for predicate cigarette brand

350

350

$
8,239

$
8,494
During the third quarter of 2019, in connection with the Company’s recent management changes, the Company decided on a going-forward basis that it will be concentrating its business and scientific resources, personnel and efforts on the portion of our intellectual property portfolio (patents, patent applications and trademarks) that relate to very low nicotine tobacco plants and potential products, as well as unique hemp/cannabis plants and potential products, in order to more strategically pursue our objectives. Accordingly, during the third quarter of 2019, we recorded a non-cash impairment charge of $1,142,349 (cost of $2,092,485 less accumulated amortization of $950,136) relating to patent and trademark costs not associated with these strategic objectives. This impairment charge is included as a separate line item in operating expenses on the Company’s Consolidated Statements of Operations and Comprehensive (Loss) Income.
September 30, December 31,
2019 2018
Intangible assets, net
Patent and trademark costs $ 7,734,434 $ 7,136,774
Less: impairment 2,092,485 -
    Patent and trademark costs after impairment 5,641,949 7,136,774
Less: accumulated amortization before impairment 3,686,792 3,194,565
Accumulated amortization relating to impairment costs 950,136 -
    Accumulated amortization after impairment 2,736,656 3,194,565
Patent and trademark costs, net 2,905,293 3,942,209

License fees, net (see Note 9) 3,776,427 3,776,426
Less: accumulated amortization 648,009 469,131
License fees, net 3,128,418 3,307,295

MSA signatory costs 2,202,000 2,202,000

License fee for predicate cigarette product 300,000 300,000

$ 8,535,711 $ 9,751,504
10

Amortization expense relating to the above intangible assets for the three and ~~nine~~six months ended ~~September~~June 30, ~~2019~~2020 amounted to ~~$232,753~~$189 and ~~$671,105,~~$361 respectively ($~~219,171~~223 and ~~$557,648~~$438 for the three and ~~nine~~six months ended ~~September 30, 2018, respectively).~~
~~The estimated annual average amortization expense for the next five years is approximately $343,600 for patent costs and $236,000 for license fees.~~
~~Impairment of Long-Lived Assets~~- The Company reviews the carrying value of its amortizing long-lived assets whenever events or changes in circumstances indicate that the historical cost-carrying value of an asset may no longer be recoverable. The Company assesses recoverability of the asset by estimating the future undiscounted net cash flows expected to result from the asset, including eventual disposition. If the estimated future undiscounted net cash flows are less than the carrying value of the asset, an impairment loss is recorded equal to the difference between the asset’s carrying value and its fair value. In connection with our recent management changes, there was a non-cash impairment loss recorded during the three and nine months ended SeptemberJune 30, 2019 ~~of approximately $1,142,000 (see the above disclosures relating to intangible assets), and no impairments were recorded during the three and nine months ended September 30, 2018.~~
~~Income Taxes~~ -~~The Company recognizes deferred tax assets and liabilities for any basis differences in its assets and liabilities between tax and GAAP reporting, and for operating losses and credit carryforwards.~~
As a result of the Company’s history of cumulative net operating losses and the uncertainty of their future utilization, the Company has established a valuation allowance to fully offset its net deferred tax assets as of September 30, 2019 and December 31, 2018. Additionally, because the Company has a full valuation allowance offsetting its deferred tax assets and as a result has an effective tax rate of zero, the Company has elected to present other comprehensive income items relating to net unrealized gains on short-term investment securities gross and not net of taxes.
The Company’s federal and state tax returns for the years ended December 31, 2016 through December 31, 2018 are currently open to audit under the statutes of limitations. There were no pending audits as of September 30, 2019.
~~Stock Based Compensation -~~ The Company uses a fair-value based method to determine compensation for all arrangements under which Company employees and others receive shares, restricted stock units or options to purchase common shares of the Company. Stock based compensation expense is recorded over the requisite service period based on estimates of probability and time of achieving milestones and vesting. For accounting purposes, the shares will be considered issued and outstanding upon vesting or risks of forfeiture expiring.
~~Revenue Recognition~~ -On January 1, 2018, the Company adopted ASC 606, Revenue from Contracts with Customers and all related amendments (the “new revenue standard”) for all contracts using the modified retrospective method. Under the modified retrospective method, the Company was required to record a cumulative-effect adjustment to the opening balance of retained earnings on January 1, 2018. The Company determined that the adoption of the new revenue standard did not require a cumulative-effect adjustment.
11
The Company recognizes revenue when it satisfies a performance obligation by transferring control of the product to a customer. The Company’s customer contracts consist of obligations to manufacture the customer’s filtered cigars and cigarettes. For certain contracts, the performance obligation is satisfied over time as the Company determines, due to contract restrictions, it does not have an alternative use of the product, and it has an enforceable right to payment as the product is manufactured. The Company recognizes revenue under those contracts at the unit price stated in the contract based on the units manufactured. The manufacturing process is completed daily and, therefore, there were no performance obligations partially satisfied at September 30, 2019. For the contract where the performance obligation is satisfied at a point in time, the Company recognizes revenue when the product is transferred to the customer. Revenue from the sale of the Company’s products is recognized net of cash discounts, sales returns and allowances. There was no allowance for discounts or returns and allowances at September 30, 2019 and December 31, 2018.
The Company generally requires a down payment from its customers prior to commencement of manufacturing a product. Amounts received in advance of satisfying the performance obligations are recorded as deferred revenue. Customer payment terms vary depending on the terms of each customer contract, but payment is generally due prior to product shipment or within extended credit terms up to twenty-one (21) days after shipment.
The Company’s net sales revenue is derived from customers located primarily in the United States of America and is disaggregated by the timing of revenue recognition. For the three and nine months ended September 30, 2019, net sales revenue from products transferred over time amounted to approximately $3,835,000 and $11,491,000, respectively (approximately $3,987,000 and $12,479,000 for the three and nine months ended September 30, 2018, respectively), and net sales revenue from products transferred at a point in time amounted to approximately $2,627,000 and $7,080,000, respectively (approximately $2,273,000 and $6,812,000 for the three and nine months ended September 30, 2018, respectively).
The Company had certain customers whose revenue individually represented 10% or more the Company’s total revenue and whose accounts receivable balances individually represented 10% or more the Company’s total accounts receivable. For the three and nine months ended September 30, 2019, and 2018, three customers accounted for over 90% of our revenue and approximately 97% and 92%, respectively, of accounts receivable at September 30, 2019 and December 31, 2018.
~~Derivatives~~-The Company does not use derivative instruments to hedge exposures to cash flow, market or foreign currency risks. The Company evaluates its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. Derivative financial instruments are initially recorded at fair market value and then are revalued at each reporting date, with changes in fair value reported in the Consolidated Statements of Operations and Comprehensive (Loss) Income. The classification of derivative instruments is evaluated at the end of each reporting period. Derivative instruments are classified on the balance sheet as current or non-current based on if the net-cash settlement of the derivative instrument could be required within twelve months of the balance sheet date.
~~Research and Development~~ -~~Research and development costs are expensed as incurred.~~
~~(Loss) Income Per Common Share -~~Basic (loss) income per common share is computed using the weighted-average number of common shares outstanding. Diluted (loss) income per share is computed assuming conversion of all potentially dilutive securities. Potential common shares outstanding are excluded from the computation if their effect is anti-dilutive.
12
~~Use of Estimates~~ -The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates.
~~Fair Value of Financial Instruments -~~ The Company’s financial instruments include cash and cash equivalents, short-term investment securities, accounts receivable, investment (stock warrants), accounts payable, accrued expenses, and notes payable. Other than for cash equivalents, short-term investment securities, and investment (stock warrants), fair value is assumed to approximate carrying values for these financial instruments, since they are short term in nature, they are receivable or payable on demand, or had stated interest rates that approximate the interest rates available to the Company as of the reporting date. The determination of the fair value of cash equivalents, short-term investment securities, and investment (stock warrants) are discussed in Note 5.
~~Investments -~~ The Company accounts for investments in equity securities of other entities under the equity method of accounting if the Company’s investment in the voting stock of the other entity is greater than or equal to 20% and less than a majority, and the Company has the ability to have significant influence over the operating and financial policies of the investee. If the Company’s equity investment in other entities is less than 20%, and the Company has no significant influence over the operating or financial policies of the entity, and such equity investment does not have a readily determinable market value, then the Company accounts for such equity investments in accordance with FASB ASU 2016-01, which the Company adopted in the first quarter of 2018 with respect to the Company’s former investment in Anandia Laboratories, Inc. in Canada (see Note 4 for a further discussion).
The Company has an investment in stock warrants that are considered equity securities under ASC 321 – Investments – Equity Securities and a derivative instrument under ASC 815 – Derivatives and Hedging. The stock warrants are not designated as a hedging instrument, and in accordance with ASC 815, the Company’s investment in stock warrants are recorded at fair value with changes in fair value recorded in the Company’s Consolidated Statements of Operations and Comprehensive (Loss) Income.
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~~NOTE 2. - MACHINERY AND EQUIPMENT~~
~~Machinery and equipment at September 30, 2019 and December 31, 2018 consisted of the following:~~
Useful Life September 30,
2019 December 31,
2018
Cigarette manufacturing equipment 3 - 10 years $ 4,841,828 $ 4,608,267
Office furniture, fixtures and equipment 5 years 152,454 135,909
Laboratory equipment 5 years 124,627 104,709
Leasehold improvements 6 years 256,604 169,362
5,375,513 5,018,247
Less: accumulated depreciation 2,134,169 1,757,499
Machinery and equipment, net $ 3,241,344 $ 3,260,748
Depreciation expense was $157,654 and $439,955 for the three and nine months ended September 30, 2019, respectively ($132,846 and $388,668 for the three and nine months ended September 30, 2018, respectively).
~~NOTE 3. - RIGHT-OF-USE ASSETS, LEASE OBLIGATIONS, AND OTHER LEASES~~
On January 1, 2019, the Company adopted ASU 2016-02, Subtopic ASC 842, Leases (the “new guidance”). Under the new guidance, the Company was required to evaluate its leases and record a Right-of-use (“ROU”) asset and a corresponding lease obligation for leases that qualified as either finance or operating leases. Prior to the adoption of the new guidance, the Company had various operating leases for real estate. The Company elected to use the practical expedient which allowed the Company to carry forward the historical lease classifications of the existing leases. The Company determined that its leases contained (1) no variable lease expenses, (2) no termination options, (3) no residual lease guarantees, and (4) no material restrictions or covenants. The new guidance calls for the lease obligations to be recorded at the present value of the remaining lease payments under the leases and the ROU assets are recorded as the sum of the present value of the lease obligations plus any initial direct costs minus lease incentives plus prepaid lease payments. All remaining renewal options have been included in the computation of the ROU assets and lease obligations. The present value of the remaining lease payments was computed using a discount rate of 5.14%. The Company determined that two real estate leases qualified as operating leases under the new guidance as discussed below.
The Company leases a manufacturing facility and warehouse located in North Carolina on a triple net lease basis with a monthly lease payment of $14,094. As of January 1, 2019, the lease had a remaining term of thirty-four (34) months including all renewal options. Under the new guidance, the Company recorded a ROU asset and a corresponding lease obligation in the amount of $446,950 on January 1, 2019 and recorded a lease Impairment expense for the three and ~~nine~~six months ended ~~September~~June 30, ~~2019~~2020 amounted to $146 (cost of approximately ~~$42,300 and $126,800, respectively.~~
~~On October 4, 2017,~~$448 less accumulated amortization of approximately $302). The impairment related to patent intellectual property that would be expired before the Company entered a lease for office space at a location in Williamsville, New York with an initial monthly lease payment of $6,375 per month for the first three years of the lease. The monthly lease payment increases by 5% annually for the remainder of the lease. As of January 1, 2019, the lease had a remaining term of sixty-two (62) months including all renewal options. Under the new guidance, the Company recorded a ROU asset and a corresponding lease obligation in the amount of $367,325 on January 1, 2019 and recorded a lease expense for the three and nine months ended September 30, 2019 of approximately $20,300 and $60,800, respectively.planned to commercialize.

As of September 30, 2019, the ROU assets and corresponding operating lease obligations had a balance of $655,193, with $217,013 and $438,180 of the operating lease obligation shown as current and long-term, respectively.
14
Further, FASB issued ASU 2018-11, Re-Leases Targeted Improvements to ASC 842, to provide entities with relief from the costs of implementing certain aspects of the new guidance. Under ASU 2018-11, entities may elect not to recast comparative periods when transitioning to the new guidance. The Company has adopted ASU 2018-11, and accordingly, will (1) apply ASC 840 Lease Accounting (the “old guidance”) in comparative periods, (2) provide disclosures for all comparative periods presented in accordance with the old guidance, and (3) recognize the effects of applying the new guidance as a cumulative-effects adjustment to retained earnings as of January 1, 2019. No cumulative-effects adjustment was made as the Company determined it to be immaterial.
~~In addition, the Company has two leases that did not qualify as operating or financing leases under the new guidance as discussed below.~~
On August 14, 2017, the Company entered into a lease for warehouse space in North Carolina to store and operate tobacco leaf processing equipment, to store the Company’s proprietary tobacco leaf and to store inventory used in the Company’s contract manufacturing business. The lease calls for a monthly payment of $4,665, and expires on August 14, 2020.
On May 1, 2016, the Company entered a sublease for laboratory space in Buffalo, New York. After a series of sublease amendments that increased the subleased laboratory space and monthly sublease payment, on February 21, 2018 the Company entered into a new sublease amendment that further increased the lab space, extended the sublease term through September 30, 2019 and called for a monthly sublease payment of $5,540 beginning on March 1, 2018. On June 21, 2019, the Company entered a temporary lease extension through August 31, 2019. The temporary lease was further extended by six months through February 29, 2020. The lease expense for the three and nine months ended September 30, 2019 amounted to approximately $17,000 and $51,000, respectively ($17,000 and $45,000 for three and nine months ended September 30, 2018, respectively).
The Company is currently in discussions with the lessors of the above two leases for these facilities to amend the leases. Any new leases that may result from these discussions will be evaluated under the new lease guidance.
15

NOTE ~~4. - INVESTMENT~~
The Company (through its wholly-owned subsidiary, Botanical Genetics) held an equity investment in Anandia Laboratories, Inc. (“Anandia”), a Canadian plant biotechnology company. On August 8, 2018, all of Anandia’s outstanding common stock was acquired by Aurora Cannabis, Inc. (“Aurora”), a Canadian company (NYSE: ACB and TSX: ACB), and as a result the Company received in exchange for its Anandia equity: (i) 1,947,943 free trading shares of Aurora common stock, and (ii) a stock warrant to purchase 973,971 shares of Aurora common stock. The Company sold all the shares of Aurora common stock during the third quarter of 2018, but retains ownership of the stock warrant to purchase 973,971 shares of Aurora common stock as of September 30, 2019. The stock warrant has a five-year contractual term, an exercise price of $9.37 per share (Canadian Dollars; approximately $7.05 per share U.S. Dollars at September 30, 2019), is currently exercisable, is considered an equity security, and is recorded at fair value (Level 3 of the valuation hierarchy). The Company recorded the fair value of the Aurora common stock warrant of $1,682,048 and $3,092,358 at September 30, 2019 and December 31, 2018, respectively, using the Black-Scholes pricing model and was classified within Other assets on the Company’s Consolidated Balance Sheets. The Company recorded an unrealized loss, the adjustment to fair value, in the amount of $2,959,898 and $1,410,310 for the three and nine months ended September 30, 2019, respectively. The Company recorded an unrealized gain, the adjustment to fair value, in the amount of $3,923,156 for the three and nine months ended September 30, 2018, respectively.
~~Effective January 1, 2018, the Company adopted Financial Accounting Standards Board ASU 2016-01, Financial Instruments~~8. – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. This guidance changed how entities account for equity investments that do not result in consolidation and are not accounted for under the equity method of accounting. Under ASU 2016-01, the Company was required to measure its investment in Anandia at fair value at the end of each reporting period and recognize changes in fair value in net income. As allowed by ASU 2016-01, since the Company’s investment in Anandia did not have readily determinable fair value, the Company elected to account for its investment at cost. The cost basis is required to be adjusted in the event of impairment, if any, and for any observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Accordingly, and as a result of, an equity issuance in January of 2018 by Anandia that was considered an orderly transaction, the Company recorded an unrealized gain on its investment in Anandia in the amount of $6,147,088 during the first quarter of 2018. There were no further changes in the fair value of the Company’s equity investment in Anandia through the acquisition of Anandia by Aurora on August 8, 2018, as discussed above.
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~~NOTE 5. - FAIR VALUE MEASUREMENTS AND SHORT-TERM INVESTMENTS~~
FASB ASC 820 - “Fair Value Measurements and Disclosures” establishes a valuation hierarchy for disclosure of the inputs to valuation used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows:
· ~~Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities;~~
· Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument; and
· ~~Level 3 inputs are unobservable inputs based on the Company’s own assumptions used to measure assets and liabilities at fair value.~~
~~A financial asset’s or a financial liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.~~
The following table presents information about our assets and liabilities measured at fair value at September 30, 2019 and December 31, 2018, and indicates the fair value hierarchy of the valuation techniques the Company utilized to determine such fair value:
Asset and Liabilities at Fair Value
As of September 30, 2019
Level 1 Level 2 Level 3 Total
Assets
Short-term investment securities:
Money market funds $ 13,162,876 $ - $ - $ 13,162,876
Corporate bonds - 26,740,868 - 26,740,868
U.S. treasury securities - 1,997,813 - 1,997,813
U.S. government agency bonds - 1,199,621 - 1,199,621
Total short-term investment securities $ 13,162,876 $ 29,938,302 $ - $ 43,101,178
Investment:
Stock warrant $ - $ - $ 1,682,048 $ 1,682,048
Asset and Liabilities at Fair Value
As of December 31, 2018
Level 1 Level 2 Level 3 Total
Assets
Short-term investment securities:
Money market funds $ 10,083,972 $ - $ - $ 10,083,972
Corporate bonds - 38,579,055 - 38,579,055
U.S. treasury securities - 2,970,900 - 2,970,900
U.S. government agency bonds - 4,115,012 - 4,115,012
Total short-term investment securities $ 10,083,972 $ 45,664,967 $ - $ 55,748,939

Investment:
Stock warrant $ - $ - $ 3,092,358 $ 3,092,358
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Money market mutual funds are valued at their daily closing price as reported by the fund. Money market mutual funds held by the Company are open-end mutual funds that are registered with the SEC that generally transact at a stable $1.00 Net Asset Value (“NAV”) representing its estimated fair value. On a daily basis the fund’s NAV is determined by the fund based on the amortized cost of the funds underlying investments.
~~U.S. government agency bonds, U.S. treasury securities, and corporate bonds are valued using pricing models maximizing the use of observable inputs for similar securities.~~
The investment in the Aurora stock warrant is measured at fair value using the Black-Scholes pricing model and is classified within Level 3 of the valuation hierarchy. The unobservable input is an estimated volatility factor of 68.5% and 92% at September 30, 2019 and December 31, 2018, respectively. A 20% increase or decrease in the volatility factor used at September 30, 2019 would have the impact of increasing or decreasing the fair value measurement of the stock warrants by approximately $427,000.
~~The following table sets forth a summary of the changes in fair value of the Company’s stock warrant (Level 3 asset) since December 31, 2017:~~
Fair value at December 31, 2017 $ -
Fair value of stock warrants acquired on August 8, 2018 2,807,958
Unrealized gain as a result of change in fair value 284,400
Fair value at December 31, 2018 3,092,358
Unrealized gain as a result of change in fair value first quarter 2019 2,973,533
Fair value at March 31, 2019 6,065,891
Unrealized loss as a result of change in fair value second quarter 2019 (1,423,945 )
Fair value at June 30, 2019 4,641,946
Unrealized loss as a result of change in fair value third quarter 2019 (2,959,898 )
Fair value at September 30, 2019 $ 1,682,048
The following tables sets forth a summary of the Company’s available-for-sale securities in its short-term investment account from amortized cost basis to fair value at September 30, 2019 and December 31, 2018:
Available-for-Sale Securities – September 30, 2019
Amortized Gross Gross
Cost Unrealized Unrealized Fair
Basis Gains Losses Value
Corporate bonds $ 26,656,949 $ 104,186 $ (20,266 ) $ 26,740,869
U.S. treasury securities 1,967,031 30,781 - 1,997,812
U.S. government agency bonds 1,200,000 - (379 ) 1,199,621

$ 29,823,980 $ 134,967 $ (20,645 ) $ 29,938,302
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Available-for-Sale Securities – December 31, 2018
Amortized Gross Gross
Cost Unrealized Unrealized Fair
Basis Gains Losses Value
Corporate bonds $ 38,579,541 $ 48,796 $ (49,282 ) $ 38,579,055
U.S. treasury securities 2,959,063 11,837 - 2,970,900
U.S. government agency bonds 4,099,321 15,691 - 4,115,012

$ 45,637,925 $ 76,324 $ (49,282 ) $ 45,664,967
The following table sets forth a summary of the Company’s available-for-sale securities in its short-term investment account for amortized cost basis and fair value by contractual maturity at September 30, 2019 and December 31, 2018:
Available-for-Sale
Securities Available-for-Sale
Securities
September 30, 2019 December 31, 2018
Amortized Amortized
Cost Basis Fair Value Cost Basis Fair Value
Due in one year or less $ 16,802,913 $ 16,889,015 $ 43,050,306 $ 43,082,677
Due after one year through two years 13,021,067 13,049,287 2,587,619 2,582,290

$ 29,823,980 $ 29,938,302 $ 45,637,925 $ 45,664,967
~~NOTE 6. -~~ NOTES PAYABLE ~~FOR LICENSE FEE~~
License Fees
On June 22, 2018, the Company entered into the Second Amendment to the License Agreement (the “Second Amendment”) with North Carolina State University (“NCSU”) that amended an original License Agreement between the Company and NCSU, dated December 8, 2015, and the First Amendment, dated February 14, 2018, to the original License Agreement. Under the terms of the Second Amendment, the Company iswas obligated to pay NCSU milestone payments totaling ~~$1,200,000, of~~$1,200, which amount $500,000 was payable upon execution of the Second Amendment, $400,000 was payable on the first anniversary of the execution of the Second Amendment, and $300,000 will be payable on the second anniversary of the execution of the Second Amendment. The Company has recorded theoriginally amounted to a present value of $1,175. As of June 30, 2020 the ~~obligations under~~Company paid the ~~Second Amendment as a note payable that originally amounted to $1,175,226.~~final milestone payment of $300. The cost of the of acquired license amounted to ~~$1,175,226~~$1,175 and is included in Intangible assets, net on the Company’s Consolidated Balance Sheets, and ~~will be~~is amortized on a straight-line basis over the last-to-expire patent, which is expected to be in 2036.
On October 22, 2018, the Company entered into a License Agreement with the University of Kentucky. Under the terms of the License Agreement, the Company is obligated to pay the University of Kentucky milestone payments totaling ~~$1,200,000,~~$1,200, of which ~~amount $300,000~~$300 was payable upon execution, ~~$300,000 was paid on the first anniversary of the execution of the License Agreement~~ and ~~$300,000~~$300 will be payable annually over ~~the next two~~3 years on the anniversary of the execution of the License Agreement. The Company has recorded the present value of the obligations under the License Agreement as a note payable that originally amounted to ~~$1,151,201.~~$1,151. The cost of the of acquired licenses amounted to ~~$1,151,201~~$1,151 and is included in Intangible assets, net on the Company’s Consolidated Balance Sheets, and will be amortized on a straight-line basis over the last-to-expire patent, which is expected to be in 2033.
CARES Act Paycheck Protection Program Loan
19
~~After~~On May 1, 2020, the ~~accretion~~Company received an U.S. Small Business Administration Loan (“SBA Loan”) from Bank of ~~interest during~~America, N.A. related to the ~~three and nine months ended September 30, 2019~~COVID-19 crisis in the amount of ~~$8,178~~$1.2 million. On May 12, 2020, the Company repaid the SBA loan in full.
D&O Insurance
During the second quarter of 2020, the Company renewed its Director and ~~$28,730, respectively,~~Officer (“D&O”) insurance for a one-year policy premium totaling $2,744. The Company paid $549 as a premium down payment and financed the ~~balance~~ remaining ~~on these two~~$2,195 of policy

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premiums over nine months at a 3.19% annual percentage rate. The financed amount is recorded within current notes payable ~~as of September 30, 2019 amounted to $1,166,095, with $576,736 and $589,359 reported as current and long-term, respectively,~~ on the Company’s Consolidated Balance ~~Sheets (notes~~Sheets.
The table below outlines our notes payable ~~balance of $1,537,365~~balances as of June 30, 2020 and December 31, ~~2018, with $689,148~~2019:

June 30,

December 31,

2020

2019

License Fees

$
293

$
581

D&O Insurance

1,954

—

Total current notes payable

$
2,247

$
581

Long term license fees

$
292

$
292

Accretion of non-cash interest expense amounted to $6 and ~~$848,217 reported as current~~$13 for the three and ~~long-term, respectively).~~six months ended June 30, 2020, respectively, and $10 and $21 for the three and six months ended June 30, 2019, respectively.
NOTE ~~7. -~~9. – SEVERANCE LIABILITY
~~The~~During the second quarter of 2020, the Company recorded an accrual for ~~employee~~ severance ~~during~~benefits for $306 in accordance with FASB ASC 712 - “Compensation – Nonretirement Postemployment Benefits.” Consistent with certain contractual obligations related to a resignation, the Company will provide cash payments and full reimbursement for health insurance premiums under the Consolidated Omnibus Budget Reconciliation Act (“COBRA”). The cash payments will be paid over a twelve-month period, on a bi-weekly basis, and the COBRA health insurance premiums will be reimbursed over twelve months.

During the third quarter of 2019, in the ~~initial amount of $720,838~~Company recorded an accrual for severance benefits for $721 in accordance with FASB ASC 712 - “Compensation – Nonretirement Postemployment Benefits.” The severance accrual relates to the resignation of the Company’s former President and Chief Executive Officer (the “former CEO”) effective July 26, 2019. Concurrent with the former CEO’s resignation, the Company entered into a Consulting Agreement (the “Agreement”) with the former CEO. The Agreement calls for the Company to pay a monthly consulting fee to the former CEO in the amount of ~~$16,667~~$17 plus health insurance benefits for a period of forty-two months. The Company concluded that the terms of the Agreement met the severance criteria in ASC 712 and accordingly, a severance accrual was recorded.
The Company computed the present value of the payments called for under the Agreement and recorded an initial severance liability in the amount of $720,838. After payments under the Agreement and the accretion of interest during the third quarter of 2019, the accrued severance balance remaining ~~at September~~as of June 30, ~~2019~~2020 was ~~$695,662~~$829 with ~~$196,274~~$487 and ~~$499,388, respectively,~~$342 shown as current and long-term accrued severance, respectively, on the Company’s Consolidated Balance Sheets. The accrued severance balance remaining as of December 31, 2019 was $805 with $359 and $446 shown as current and long-term accrued severance, respectively.

NOTE 8.10. - WARRANTS FOR COMMON STOCK
~~At September 30, 2019, the~~The Company ~~had outstanding~~issued warrants to purchase 11,293,211 shares of common stock which remain outstanding as of ~~the Company with~~June 30, 2020. The warrants have an exercise price of ~~$2.15~~$1.11 per share and an expiration date of ~~December 20, 2022.~~
November 25, 2024. The ~~Company’s~~ outstanding warrants ~~at September 30, 2019~~ do not include anti-dilution features and therefore are not considered derivative instruments and do not have an associated warrant liability.

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The following table summarizes the Company’s outstanding warrant activity since December 31, ~~2017:~~2018:

Number of~~Warrants~~

Warrants

in thousands
Warrants outstanding at December 31, ~~2017~~2018

~~12,088,080~~
11,293
Warrants exercised ~~during 2018~~in Q4 2019
~~(794,869~~ )
(11,293)
Warrants issued in Q4 2019

11,293
Warrants outstanding at ~~September~~June 30, ~~2019 and December 31, 2018~~2020
~~11,293,211~~
11,293

There were no0 warrants issued or exercised during the first ~~nine~~six months of ~~2019.~~2020.

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NOTE 9.11. - COMMITMENTS AND CONTINGENCIES
License agreements and sponsored research – The Company has entered into various license, ~~agreements and~~ sponsored research, collaboration, and ~~development agreements.~~other agreements (the “Agreements”) with various counter parties in connection with the Company’s plant biotechnology business relating to tobacco and hemp/cannabis. The ~~costs~~schedule below summarizes the Company’s commitments, both financial and other, associated with each Agreement. Costs incurred under the ~~following three agreements~~Agreements are ~~initially~~generally recorded as ~~a Prepaid expense on the Company’s Consolidated Balance Sheets and subsequently expensed on a straight-line basis over the applicable period and included in~~ Research and development costs on the Company’s Consolidated Statements of Operations and Comprehensive (Loss) Income. The amounts expensed during the three and nine months ended September 30, 2019 were $56,250 and $209,202, respectively ($86,589 and $307,659 for three and nine months ended September 30, 2018, respectively).
Under its exclusive worldwide license agreement with North Carolina State University (“NCSU”), the Company is required to pay minimum annual royalty payments, which are credited against running royalties on sales of licensed products. The minimum annual royalty is $225,000. The license agreement continues through the life of the last-to-expire patent, which is expected to be 2022. The license agreement also requires a milestone payment of $150,000 upon FDA approval or clearance of a product that uses the NCSU licensed technology. The Company is also responsible for reimbursing NCSU for actual third-party patent costs incurred. These costs vary from year to year and the Company has certain rights to direct the activities that result in these costs. During the three and nine months ended September 30, 2019, the aggregate costs incurred related to capitalized patent costs and patent maintenance expense amounted to $15,811 and $25,791, respectively ($38,394 and $72,502 for the three and nine months ended September 30, 2018, respectively).
On December 8, 2015, the Company entered into an additional license agreement (the “License”) with NCSU. Under the terms of the License, the Company paid NCSU a non-refundable, non-creditable lump sum license fee of $150,000. The License calls for the Company to pay NCSU a non-refundable, non-creditable minimum annual royalty in the amount of $15,000 in 2019, $25,000 in 2020 and 2021, and $50,000 per year thereafter for the remaining term of the License. The Company is also responsible for reimbursing NCSU for actual third-party patent costs incurred. During the three and nine months ended September 30, 2019, the aggregate costs incurred related to capitalized patent costs and patent maintenance expense amounted to $841 and $11,740, respectively ($81,505 and $81,584 for the three and nine months ended September 30, 2018, respectively). This License continues through the life of the last-to-expire patent, expected to be in 2036.
On February 10, 2014, the Company entered into a sponsored research and development agreement (the “Agreement”) with NCSU. In February 2018, the Company finalized an additional extension to this Agreement through April 30, 2018 at a cost of $88,344. In May 2018, the Company finalized an additional extension to this Agreement through April 30, 2019 at a total cost of $121,357. During the three and nine months ended September 30, 2019 the Company expensed $0 and $40,452, respectively, under this Agreement ($30,339 and $50,585 for the three and nine months ended September 30, 2018, respectively).
~~Other license agreements~~ - Additionally, the Company has entered into the following five license agreements and the costs associated with these license agreements are included in Intangible assets, net in the Company’s Consolidated Balance Sheets and the applicable license fees will be amortized over the term of the agreements based on their last-to-expire patent date. Amortization amounted to $59,794 and $178,877 for the three and nine months ended September 30, 2019, respectively ($40,374 and $89,385 for three and nine months ended September 30, 2018, respectively), and was included in Amortization expense on the Company’s Consolidated Statements of Operations and Comprehensive (Loss) Income.
On October 22, 2018, the Company entered into a License Agreement (the “License”) with the University of Kentucky. Under the terms of the License, the Company is obligated to pay the University of Kentucky a non-refundable, non-creditable license fee of $1,200,000. The license fee is payable in accordance with a note payable more fully described in Note 6 – Notes Payable for License Fee. The present value of the payments in the amount of $1,151,201 are included in Intangible assets, net on the Company’s Consolidated Balance Sheets, and will be amortized on a straight-line basis over the last-to-expire patent, which is expected to be in 2033.
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On June 22, 2018, the Company entered into the Second Amendment to the License Agreement (the “Second Amendment”) with NCSU that amended an original License Agreement between the Company and NCSU, dated December 8, 2015. Under the terms of the Second Amendment, the Company is obligated to pay NCSU a non-refundable, non-creditable license fee of $1,200,000. The license fee is payable in accordance with a note payable more fully described in Note 6 – Notes Payable for License Fee. The present value of the payments in the amount of $1,175,226 are included in Intangible assets, net on the Company’s Consolidated Balance Sheets, and will be amortized on a straight-line basis over the last-to-expire patent, which is expected to be in 2036.
On August 22, 2014, the Company entered into a Commercial License Agreement with Precision PlantSciences, Inc. (the “Precision License”). The Precision License grants the Company a non-exclusive, but fully paid up right and license to use technology and materials owned by Precision PlantSciences for a license fee of $1,250,000. The Precision License continues through the life of the last-to-expire patent, which is expected to be in 2028.
On August 27, 2014, the Company entered into an additional exclusive License Agreement (the “License Agreement”) with NCSU. Under the License Agreement, the Company paid NCSU a non-refundable, non-creditable lump sum license fee of $125,000, and the Company must pay to NCSU an additional non-refundable, non-creditable lump sum fee of $75,000 upon issuance of a U.S. utility patent included in the patent rights. The Company is obligated to pay to NCSU an annual minimum royalty fee of $30,000 in 2019 and $50,000 per year thereafter for the remaining term of the License Agreement. The Company is also responsible for reimbursing NCSU for actual third-party patent costs incurred. During the three and nine months ended September 30, 2019, the aggregate costs incurred related to capitalized patent costs and patent maintenance expense amounted to $5,044 and $17,574, respectively ($2,140 and $11,605 for three and nine months ended September 30, 2018, respectively). The License Agreement continues through the life of the last-to-expire patent, which is expected to be in 2034.
On September 15, 2014, the Company entered into a Sublicense Agreement with Anandia Laboratories, Inc. (the “Anandia Sublicense”). Under the terms of the Anandia Sublicense, the Company was granted an exclusive sublicense in the United States and a co-exclusive sublicense in the remainder of the world, excluding Canada, to the licensed intellectual property. The Anandia Sublicense required an up-front fee of $75,000, an annual license fee of $10,000, the payment of patent filing and maintenance costs, a running royalty on future net sales of products made from such sublicensed intellectual property, and a sharing of future sublicensing consideration received from sublicensing to third-parties such sublicensed intellectual property. The Anandia Sublicense continues through the life of the last-to-expire patent, which is expected to be in 2035. As discussed in Note 4, Anandia was purchased by Aurora on August 8, 2018 and has become a wholly-owned subsidiary of Aurora. The Anandia Sublicense is still in effect.
~~Other research agreements~~- ~~Further, the Company has entered into the following three agreements relating to sponsored research. Costs associated with these agreements are expensed when incurred in Research and development costs~~expenses on the Company’s Consolidated Statements of Operations and Comprehensive Loss.

Future Commitments

Commitment

Counter Party

Product Relationship

Commitment Type

2020

2021

2022

2023

2024 & After

Total

Research Agreement

KeyGene

Hemp / Cannabis

Contract fee

$
600

$
1,200

$
1,200

$
1,200

$
295

$
4,495
(1)
License Agreement

NCSU

Tobacco

Annual royalty fee

113

225

225

—

—

563
(2), (3)
License Agreement

NCSU

Tobacco

Minimum annual royalty

25

25

50

50

650

800
(3)
License Agreement

NCSU

Tobacco

Minimum annual royalty

50

50

50

50

550

750
(3)
Sublicense Agreement

Anandia Laboratories, Inc.

Hemp / Cannabis

Annual license fee

10

10

10

10

120

160
(4)
Growing Agreement

Various

Various

Contract fee

75

—

—

—

—

75
(5)

$
873

$
1,510

$
1,535

$
1,310

$
1,615

$
6,843

On September 28, 2015, the Company’s wholly-owned subsidiary, Botanical Genetics, entered into a Sponsored Research Agreement (the “Agreement”) with Anandia Laboratories Inc. (“Anandia”). Pursuant to the Agreement, Anandia conducted research on behalf of the Company relating to the hemp/cannabis plant. During the three and nine months ended September 30, 2019, no expenses related to the Agreement were incurred ($0 and $130,850 for three and nine months ended September 30, 2018, respectively). On October 17, 2019, Anandia notified the Company that the Agreement has expired and Anandia continues to be in the process of transferring to the Company the Company’s share of all results, data and hemp germplasm developed by Anandia under the Agreement. Under the terms of the Agreement, the Company will continue to have co-exclusive worldwide rights with Anandia to all the intellectual property resulting from the sponsored research between the Company and Anandia. The party that commercializes such intellectual property in the future will pay royalties in varying amounts to the other party, with the amount of such royalties being dependent upon the type of products that are commercialized in the future. If either party sublicenses such intellectual property to a third-party, then the Company and Anandia will share equally in such sublicensing consideration. As discussed in Note 4, Anandia was purchased by Aurora on August 8, 2018 and has become a wholly-owned subsidiary of Aurora.
22(1) Exclusive agreement with the Company with respect to the Cannabis Sativa L. plant (the "Field"). The initial term of the agreement is five years with an option for an additional two years. The aggregate cost of the agreement over the initial term is $6,000. The Company will exclusively own all results and all intellectual property relating to the results of the collaboration with KeyGene (the "Results”). The Company will pay royalties in varying amounts to KeyGene relating to the Company's commercialization in the Field of certain Results. The Company has granted KeyGene a license to commercialize the Results outside of the Field and KeyGene will pay royalties in varying amounts to the Company relating to KeyGene's commercialization outside of the Field of the Results.
(2) The license agreement also requires a milestone payment of $150 upon FDA approval or clearance of a product that uses the NCSU licensed technology. The annual royalty fee is credited against running royalties on sales of licensed products.
(3) The Company is also responsible for reimbursing NSCU for actual third-party patent costs incurred, including capitalized patent costs and patent maintenance costs. These costs vary from year to year and the Company has certain rights to direct the activities that result in these costs.
(4) The Company is also responsible for the payment of certain costs, including, capitalized patent costs and patent maintenance costs, a running royalty on future net sales of products made from the sublicensed intellectual property, and a sharing of future sublicensing consideration received from sublicensing to third parties.
(5) Various R&D growing agreements for hemp / cannabis and tobacco.
InInvestment in Panacea - On December 2016, the Company entered into a new sponsored research agreement with the University of Virginia (“UVA”) and an exclusive license agreement with the University of Virginia Patent Foundation d/b/a University of Virginia Licensing & Ventures Group (“UVA LVG”) pursuant to which the Company will invest approximately $1,000,000 over a three-year period with UVA to create unique industrial hemp plants with levels of THC below the legal limits and optimize other desirable hemp plant characteristics to improve the plant’s suitability for growing in Virginia and other legacy tobacco regions of the United States. This work with UVA will also involve the development and study of medically important cannabinoids to be extracted by UVA from the Company’s hemp plants. UVA and the Company will conduct all activities in this scientific collaboration within the parameters of state and federal licenses and permits held by UVA for such work. The agreements with UVA and UVA LVG grant the Company exclusive rights to commercialize all results of the collaboration in consideration of royalty payments by the Company to UVA LVG. During the three and nine months ended September 30, 2019, expenses related to the agreements amounted to $138,796 and $269,154, respectively ($116,265 and $296,443 for three and nine months ended September 30, 2018, respectively).
On May 1, 2018, the Company entered into a University Growing and Evaluation Agreement (the “Agreement”) with the University of Kentucky Research Foundation (“UKRF”) whereby UKRF will provide the Company with services relating to growing certain tobacco breeding lines of the Company. Under the Agreement, the Company is obligated to pay $75,000 to UKRF in three installments of $25,000 each through January 31, 2019. During the three and nine months ended September 30, 2019, expenses related to the Agreement amounted to $0 and $25,000, respectively ($25,000 and $50,000 for three and nine months ended September 30, 2018, respectively).
On February 1, 2019, the Company entered into a Master Collaboration and Research Agreement (the “Agreement”) with a Natural Good Medicines, LLC (“NGM”), the owners of certain hemp and cannabis plant lines (the “NGM Material”). The Agreement calls for NGM to cultivate, grow and process a certain amount of the NGM Material with the financial support of the Company. NGM has granted the Company certain exclusive rights to the hemp and cannabis plant lines of NGM. Additionally, three (3) years from the effective date of the Agreement, NGM and the Company will mutually share in the proceeds from the sale of non-propagating parts of the NGM Material. The Company’s total financial commitment under the Agreement is $403,000, which has been included in Research and development expenses on the Company’s Statements of Operations and Comprehensive (Loss) Income for the nine months ended September 30, 2019.
~~On April~~ 3, 2019, the Company entered into an agreement to obtain a ~~Framework Collaborative Research Agreement (the “Agreement”)~~15.8% ownership in Panacea. The Company paid Panacea $12,000 in cash and issued 1,297,017 shares of 22nd Century common stock with ~~KeyGene N.V. (“KeyGene”) under which KeyGene has agreed to work exclusively~~a fair value of $1,297. The agreement with Panacea also requires the Company ~~with respect~~ to ~~the~~~~Cannabis Sativa L~~~~. plant~~purchase 5,333,334 shares of puttable preferred stock at $1.875 when Panacea achieves a certain twelve-month sales target that is payable in $8,500 of cash and ~~all uses thereof (the “Field”). The initial term is for five (5) years with an option for an additional two (2) years~~the remainder in ~~consideration~~common stock of the ~~Company paying KeyGene an aggregate~~Company.

Table of Six Million United States Dollars ($6,000,000) over the initial term of the Agreement. A minimum of $1,200,000 will be paid annually during the initial term of the Agreement with a portion of such amount being paid based on KeyGene achieving certain milestone deliverables for the Company. The Company will exclusively own all results and all intellectual property relating to the results from this collaboration with KeyGene (“Results”). The Company will pay royalties in varying amounts to KeyGene relating to the Company’s commercialization in the Field of certain Results. The Company has granted KeyGene a license to commercialize the Results outside of the Field and KeyGene will pay royalties in varying amounts to the Company relating to KeyGene’s commercialization outside of the Field of the Results. The Agreement also includes customary termination provisions for both KeyGene and the Company as well as representations, warranties, and covenants by the parties that are customary for a transaction of this nature. During the three and nine months ended September 30, 2019, expenses related to the agreement amounted to approximately $295,000 and $610,000, respectively.Contents

Modified Risk Tobacco Product Application (“MRTP Application”)– In connection with the Company’s MRTP Application for its~~Brand A~~Very Low Nicotine Content (“VLNC”) cigarettes with the FDA, the Company has entered in various contracts with third-party service providers to fulfill various requirements of the MRTP Application. Such contracts include services for clinical trials, perception studies, legal guidance, product testing, and consulting expertise. During the three and ~~nine~~six months ended ~~September~~June 30, ~~2019,~~2020, the Company incurred expenses relating to these contracts in the approximate amount of ~~$54,000~~$4 and ~~$1,578,000,~~$154, respectively, ~~($3,135,000~~ and ~~$7,155,000~~$313 and $1,524 for the three and ~~nine~~six months ended ~~September~~June 30, ~~2018, respectively).~~2019, respectively. The Company will continue to incur consulting and legal expenses as the MRTP Application continues through the FDA review process. The Company cannot currently quantify the additional expenses that the Company will incur in the FDA review process because it will involve various factors that are within the discretion and control of the FDA.

Litigation~~Litigation~~-In accordance with applicable accounting guidance, the Company establishes an accrued liability for litigation and regulatory matters when those matters present loss contingencies that are both probable and estimable. In such cases, there may be an exposure to loss in excess of any amounts accrued. When a loss contingency is not both probable and estimable, the Company does not establish an accrued liability. As a litigation or regulatory matter develops, the Company, in conjunction with any outside counsel handling the matter, evaluates on an ongoing basis whether such matter presents a loss contingency that is probable and estimable. If, at the time of evaluation, the loss contingency related to a litigation or regulatory matter is not both probable and estimable, the matter will continue to be monitored for further developments that would make such loss contingency both probable and estimable. When a loss contingency related to a litigation or regulatory matter is deemed to be both probable and estimable, the Company will establish an accrued liability with respect to such loss contingency and record a corresponding amount of related expenses. The Company will then continue to monitor the matter for further developments that could affect the amount of any such accrued liability.

~~Crede Settlement~~

On June 19, 2019, the Company, Crede CG III, LTD. (“Crede”) and Terren Peizer (“Peizer”) participated in a settlement conference meeting as required by the United States District Court for the Southern District of New York (the “SDNY Court”) entitled~~Crede CG III, LTD. v. 22nd Century Group, Inc~~. Subsequently, the Company, Crede and Peizer entered into a settlement agreement that settled this case, with the effective date of the settlement agreement being on July 22, 2019. Under the terms of the settlement agreement: (i) the Company issued to Crede on July 25, 2019 an aggregate of Nine Hundred Ninety Thousand (990,000) shares of common stock of the Company in full satisfaction of the cashless exchange of the Tranche 1A warrant and in settlement of all disputes between Crede, Peizer and the Company; (ii) Crede granted a proxy to the Company for a period of five (5) years for the Company to vote all of the shares of common stock of the Company owned by Crede in favor of the recommendations by the Company’s Board of Directors (excluding any extraordinary transactions); (iii) Crede agreed to not purchase, borrow or short any securities of the Company; and (iv) the Company, Crede and Peizer agreed to mutual releases of all claims between the parties and the dismissal of all the litigation claims and counterclaims with prejudice.

The Company accrued an expense related to the settlement of this case during the second quarter of 2019 in the amount of $1,890,900, which is equal to the fair value of the 990,000 shares of Company common stock on July 22, 2019. The accrual was reclassified to capital upon the issuance of the common stock during the third quarter of 2019.

Class Action ~~Cases~~

On January 21, 2019, Matthew Jackson Bull, a resident of Denver, Colorado, filed a Complaint against the Company, the Company’s then Chief Executive Officer, Henry Sicignano III, and the Company’s then Chief Financial Officer, John T. Brodfuehrer, in the United States District Court for the Eastern District of New York entitled:Matthew Bull, Individually and on behalf of all others similarly situated, v. 22nd Century Group, Inc., Henry Sicignano III, and John T. Brodfuehrer,Case No. 1:19-cv-00409. The Complaint alleges that Plaintiff Mr. Bull purchased shares of the Company’s common stock. Mr. Bull sues individually and seeks to bring a class action for persons or entities who acquired the Company’s common stock between February 18, 2016 and October 25, 2018, and alleges in Count I that the Company’s Annual Reports on Form 10-K for the years 2015, 2016 and 2017 allegedly contained false statements in violation of Section 10(b) of the Securities Exchange Act and Rule 10b-5 promulgated thereunder, and alleges in Count II that Messrs. Sicignano and Brodfuehrer are liable for the allegedly false statements pursuant to Section 20(a) of the Securities Exchange Act. The Complaint seeks declaratory relief, unspecified money damages, and attorney’s fees and costs. We believe that the claims are frivolous, meritless and that the Company and Messrs. Sicignano and Brodfuehrer have substantial legal and factual defenses to the claims. We intend to vigorously defend the Company and Messrs. Sicignano and Brodfuehrer against such claims.

On January 29, 2019, Ian M. Fitch, a resident of Essex County Massachusetts, filed a Complaint against the Company, the Company’s then Chief Executive Officer, Henry Sicignano III, and the Company’s then Chief Financial Officer, John T. Brodfuehrer, in the United States District Court for the Eastern District of New York entitled:Ian ~~Finch,~~Fitch, Individually and on behalf of all others similarly situated, v. 22nd Century Group, Inc., Henry Sicignano III, and John T. Brodfuehrer,Case No. 2:19-cv-00553. The Complaint filing alleges that the Plaintiff Mr. Fitch purchased shares of the Company’s common stock. Mr. Fitch sues individually and seeks to bring a class action for persons or entities who acquired the Company’s common stock between February 18, 2016 and October 25, 2018, and alleges in Count I that the Company’s Annual Reports on Form 10-K for the years 2015, 2016 and 2017 allegedly contained false statements in violation of Section 10(b) of the Securities Exchange Act and Rule 10b-5 promulgated thereunder, and alleges in Count II that Messrs. Sicignano and Brodfuehrer are liable for the allegedly false statements pursuant to Section 20(a) of the Securities Exchange Act. The Complaint seeks declaratory relief, unspecified money damages, and attorney’s fees and costs.

On March 25, 2019, Plaintiffs’ counsel in theFitch litigation filed a motion in both the Fitch and Bull actions: (1) proposing Joseph Noto, Garden State Tire Corp, and Stephens Johnson for Mr. Fitch as purportedly representative plaintiffs, (2) moving to consolidate theFitch litigation with theBull litigation, and (3) seeking to be appointed as lead counsel in the consolidated action. Plaintiffs’ counsel in theBull litigation filed and then withdrew a comparable motion seeking to consolidate the cases and be appointed as lead counsel.

On May 28, 2019, the plaintiff in theFitch case voluntarily dismissed that action. On August 1, 2019, the Court in the Bull case issued an order designating Joseph Noto, Garden State Tire Corp, and Stephens Johnson as lead plaintiffs.

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On September 16, 2019, pursuant to a joint motion by the parties, the Court in the Bull case transferred the class action to federal district court in the Western District of New York, where it remains ~~pending.~~pending as Case No. 1:19-cv-01285.

Plaintiffs in the Bull case filed an Amended Complaint on November 19, 2019. The Amended Complaint alleges that the Plaintiffs purchased shares of the Company's common stock and sues individually and to bring a class action for all persons or entities who acquired the Company's common stock between February 18, 2016 and July 31, 2019. The Amended Complaint alleges 3 counts: Count I sues the Company and Messrs. Sicignano and Brodfuehrer and alleges that the Company's quarterly and annual reports, SEC filings, press releases and other public statements and documents contained false statements in violation of Section 10(b) of the Securities Exchange Act and Rule 10b-5; Count II sues Messrs. Sicignano and Brodfuehrer pursuant to Section 10(b) of the Securities Exchange Act and Rule 10b5(a) and (c); and Count III sues Messrs. Sicignano and Brodfuehrer for the allegedly false statements pursuant to Section 20(a) of the Securities Exchange Act. The Amended Complaint seeks to certify a class, and unspecified compensatory and punitive damages, and attorney's fees and costs.

On January 3, 2020, the Court reassigned the Bull case to Judge John L. Sinatra, also in the Western District of New York.

On January 29, 2020, the Company and Messrs. Sicignano and Brodfuehrer filed a Motion to Dismiss the Amended Complaint. On March 30, 2020, Plaintiffs filed a brief in opposition to the motion to dismiss. We then filed our final reply brief on April 29, 2020. On July 31, 2020, the Court heard oral arguments on our motion to dismiss and we are awaiting their decision.

We believe that the claims are frivolous, meritless and that the Company and Messrs. Sicignano and Brodfuehrer have substantial legal and factual defenses to the claims. We intend to vigorously defend the Company and Messrs. Sicignano and Brodfuehrer against such claims.

Shareholder Derivative Cases

On February 6, 2019, Melvyn Klein, a resident of Nassau County New York, filed a shareholder derivative claim against the Company, the Company’s then Chief Executive Officer, Henry Sicignano III, the Company’s Chief Financial Officer, John T. Brodfuehrer, and each member of the Company’s Board of Directors in the United States District Court for the Eastern District of New York entitled:Melvyn Klein, derivatively on behalf of 22nd Century Group v. Henry Sicignano, III, Richard M. Sanders, Joseph Alexander Dunn, Nora B. Sullivan, James W. Cornell, John T. Brodfuehrer and 22nd Century Group, Inc.,Case No. 1:19-cv-00748. Mr. Klein brings this action derivatively alleging that (i) the director defendants supposedly breached their fiduciary duties for allegedly allowing the Company to make false statements; (ii) the director defendants supposedly wasted corporate assets to defend this lawsuit and the other related lawsuits; (iii) the defendants allegedly violated Section 10(b) of the Securities Exchange Act and Rule 10b-5 promulgated thereunder for allegedly approving or allowing false statements regarding the Company to be made; and (iv) the director defendants allegedly violated Section 14(a) of the Securities Exchange Act and Rule 14a-9 promulgated thereunder for allegedly approving or allowing false statements regarding the Company to be made in the Company’s proxy statement. The Complaint seeks declaratory relief, unspecified monetary damages, corrective corporate governance actions, and attorney’s fees and costs. On April 11, 2019, pursuant to a stipulation by the parties, the Court ordered this litigation stayed and transferred the stayed action to the Western District of New York. On April 19, 2019, the case was opened in the United States District Court for the Western District of New York, Case No. 1-19-cv-0513. On August 15, 2019, the case was consolidated with the Mathew case identified below and stayed. We believe that the claims are frivolous, meritless and that the Company and the individual defendants have substantial legal and factual defenses to the claims. We intend to vigorously defend the Company and the individual defendants against such claims. ~~On April 11, 2019, pursuant to a stipulation by the parties, the Court ordered this litigation stayed and transferred the stayed action to the Western District of New York.~~

On February 11, 2019, Stephen Mathew filed a shareholder derivative claim against the Company, the Company’s then Chief Executive Officer, Henry Sicignano III, the Company’s Chief Financial Officer, John T. Brodfuehrer, and each member of the Company’s Board of Directors in the Supreme Court of the State of New York, County of Erie, entitled:Stephen Mathew, derivatively on behalf of 22nd Century Group, Inc. v. Henry Sicignano, III, John T. Brodfuehrer, Richard M. Sanders, Joseph Alexander Dunn, James W. Cornell, Nora B. Sullivan and 22nd Century Group, Inc.,Index No. 801786/2019. Mr. Mathew brings this action derivatively alleging that (i) the director defendants supposedly breached their fiduciary duties by allegedly allowing the Company to make false statements; (ii) the director defendants were allegedly unjustly enriched by allegedly benefitting from allegedly allowing the Company to make false statements; (iii) the defendants supposedly wasted corporate assets to defend this lawsuit and the other related lawsuits; (iv) the individual defendants allegedly abused their ability to control and influence the

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Company; and (v) the individual defendants allegedly engaged in gross mismanagement. The Complaint seeks declaratory relief, unspecified monetary damages, corrective corporate governance actions, and attorney’s fees and costs. We believe that the claims are frivolous, meritless and that the Company and the individual defendants have substantial legal and factual defenses to the claims. We intend to vigorously defend the Company and the individual defendants against such claims. On April 12, 2019, the parties jointly filed a Stipulated Notice of Removal in United States District Court for the Western District of New York. On April 23, 2019, the parties jointly filed an Amended Stipulated Notice of Removal in the Western District of New York. On May 3, 2019, pursuant to a stipulation from the parties, the Court ordered this litigation stayed.

We believe that the claims are frivolous, meritless and that the Company and the individual defendants have substantial legal and factual defenses to the claims. We intend to vigorously defend the Company and the individual defendants against such claims. On August 15, 2019, the Court consolidated theMathew andKlein actions pursuant to a stipulation by the parties.

On June 10, 2019, Judy Rowley filed a shareholder derivative claim against the Company, the Company’s then Chief Executive Officer, Henry Sicignano III, the Company’s Chief Financial Officer, John T. Brodfuehrer, and each member of the Company’s Board of Directors in the Supreme Court of the State of New York, County of Erie, entitled:Judy Rowley, derivatively on behalf of 22nd Century Group, Inc. v. Henry Sicignano, III, Richard M. Sanders, Joseph Alexander Dunn, Nora B. Sullivan, James W. Cornell, John T. Brodfuehrer, and 22nd Century Group, Inc.,Index No. 807214/2019. Ms. Rowley brings this action derivatively alleging that the director defendants supposedly breached their fiduciary duties by allegedly allowing the Company to make false statements. The Complaint seeks declaratory relief, unspecified monetary damages, corrective corporate governance actions, and attorney’s fees and costs. We believe that the claims are frivolous, meritless and that the Company and the individual defendants have substantial legal and factual defenses to the claims. We intend to vigorously defend the Company and the individual defendants against such claims. On September 13, 2019, the Court ordered the litigation stayed pursuant to a joint stipulation by the parties.

On January 15, 2020, Kevin Broccuto filed a shareholder derivative claim against the Company, the Company's then Chief Executive Officer, Henry Sicignano III, the Company's Chief Financial Officer, John T. Brodfuehrer, and certain members of the Company's prior Board of Directors in the District Court of the State of Nevada, County of Clark, entitled: Kevin Broccuto, derivatively on behalf of 22nd Century Group, Inc. v. James W. Cornell, Richard M. Sanders, Nora B. Sullivan, Henry Sicignano, III, and John T. Brodfuehrer, CaseNo. A-20-808599. Mr. Broccuto brings this action derivatively alleging 3 counts: Count I alleges that the defendants breached their fiduciary duties; Count II alleges they committed corporate waste; and Count III that they were unjustly enriched, by allegedly allowing the Company to make false statements. The Complaint seeks unspecified monetary damages, corrective corporate governance actions, disgorgement of alleged profits and imposition of constructive trusts, and attorney's fees and costs. We believe that the claims are frivolous, meritless and that the Company and the individual defendants have substantial legal and factual defenses to the claims. We intend to vigorously defend the Company and the individual defendants against such claims.

On February 11, 2020, Jerry Wayne filed a shareholder derivative claim against the Company, the Company's then Chief Executive Officer, Henry Sicignano III, the Company's Chief Financial Officer, John T. Brodfuehrer, and certain members of the Company's prior Board of Directors in the District Court of the State of Nevada, County of Clark, entitled: Jerry Wayne, derivatively on behalf of 22nd Century Group, Inc. v. James W. Cornell, Richard M. Sanders, Nora B. Sullivan, Henry Sicignano, III, and John T. Brodfuehrer, Case No. A-20-808599. Mr. Wayne brings this action derivatively alleging 3 counts: Count I alleges that the defendants breached their fiduciary duties; Count II alleges they committed corporate waste; and Count III that they were unjustly enriched, by allegedly allowing the Company to make false statements. The Complaint seeks unspecified monetary damages, corrective corporate governance actions, disgorgement of alleged profits and imposition of constructive trusts, and attorney's fees and costs. The Complaint also seeks to declare as unenforceable the Company's Bylaw requiring derivative lawsuits to be filed in Erie County, New York, where the Company is headquartered. We believe that the claims are frivolous, meritless and that the Company and the individual defendants have substantial legal and factual defenses to the claims. We intend to vigorously defend the Company and the individual defendants against such claims.

On March 25, 2020, the Court ordered the Brocutto and Wayne cases consolidated and stayed pursuant to a joint stipulation from the parties.

Shareholder Derivative Demand

On February 19, 2019, the Company received a demand letter from attorneys representing Van McClendon, a shareholder of the Company, in which Mr. McClendon demanded that the Company’s Board of Directors take action to pursue certain purported causes of action on behalf of the Company to remedy alleged breaches of fiduciary duties by each of the members of the Company’s Board of Directors, the Company’s Chief Executive Officer, Henry Sicignano III, and the Company’s Chief Financial Officer, John T. Brodfuehrer. On February 28, 2019, the Board appointed a Special Committee of independent directors and instructed the Committee

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to assess whether pursuing the claims detailed in the demand letter would be in the best interests of the Company. Subsequently, Mr. McClendon sold his shares and withdrew his demand. On May 7, 2019, after Mr. McClendon sold his shares, the Company received a similar demand letter from attorneys representing Jeremy Houck, a shareholder of the Company. Pursuant to the Board’s instruction, the Special Committee ~~has been investigating whether pursuing~~completed an investigation of the claims detailed in Mr. Houck’s demand ~~letter~~letter. The Special Committee determined that pursuing such claims would not be in the best interest of the Company. On February 27, 2020, the Board of Directors adopted and approved the Special Committee’s determination.

NOTE ~~10. - (LOSS) INCOME PER COMMON SHARE~~
~~The following table sets forth the computation of basic and diluted (loss) income per common share for the three-month periods ended September 30, 2019 and 2018, respectively:~~
September 30,
2019 September 30,
2018
Net (loss) income attributed to common shareholders $ (10,245,717 ) $ 6,304,654

Denominator for basic loss per share-weighted average shares outstanding 125,420,277 124,376,061

Effect of dilutive securities:
Warrants, restricted stock units and options outstanding - 20,006,418

Denominator for diluted (loss) income per common share-weighted average shares adjusted for dilutive securities 125,420,277 144,382,479

Net (loss) income per common share – basic $ (0.08 ) $ 0.05
Net (loss) income per common share – diluted $ (0.08 ) $ 0.04
~~The following table sets forth the computation of basic and diluted (loss) income per common share for the nine-month periods ended September 30, 2019 and 2018, respectively:~~
September 30,
2019 September 30,
2018
Net (loss) income attributed to common shareholders $ (20,360,113 ) $ 952,490

Denominator for basic loss per share-weighted average shares outstanding 124,911,837 124,237,003

Effect of dilutive securities:
Warrants, restricted stock units and options outstanding - 20,006,418

Denominator for diluted (loss) income per common share-weighted average shares adjusted for dilutive securities 124,911,837 144,243,421

Net (loss) income per common share – basic $ (0.16 ) $ 0.01
Net (loss) income per common share – diluted $ (0.16 ) $ 0.01
27
Dilutive securities outstanding at September 30, 2019 and 2018, respectively, are presented below. Securities outstanding at September 30, 2019 were excluded from the computation of loss per share because they would have been anti-dilutive.
September 30,
2019 September 30,
2018
Warrants 11,293,211 11,293,211
Options 8,287,172 8,713,207
Restricted stock units 1,051,000 -
20,631,383 20,006,418
~~NOTE 11. - EQUITY~~12 – EQUITY- BASED COMPENSATION
On April 12, 2014, the stockholders of the Company approved the 22nd Century Group, Inc. 2014 Omnibus Incentive Plan (the “OIP”) and the authorization of 5,000,000 shares to be reserved for issuance thereunder. On April 29, 2017, the stockholders approved an amendment to the OIP to increase the number of shares available for issuance by an additional 5,000,000 shares and on May 3, 2019, the stockholders approved an additional amendment to the OIP to increase the number of shares available for issuance by an additional 5,000,000 shares. The OIP allows for the granting of equity and cash incentive awards to eligible individuals over the life of the OIP, including the issuance of up to an aggregate of 15,000,000 shares of the Company’s common stock pursuant to awards under the OIP. The OIP has a term of ten years and is administered by the Compensation Committee of the Company’s Board of Directors to determine the various types of incentive awards that may be granted to recipients under the OIP and the number of shares of common stock to underlie each such award under the OIP. As of ~~September~~June 30, ~~2019,~~2020, the Company had available ~~5,757,115~~4,409,969 shares remaining for future awards under the OIP.
~~During the nine months ended September 30, 2019, the Company issued awards for~~Restricted Stock (“RSU”). We grant restricted stock units ~~from~~to employees and non-employee directors which are valued based on the ~~OIP for 1,151,000 shares to eligible individuals, with such~~Company’s stock price on the award grant date. The following table summarizes the changes in unvested restricted stock ~~unit awards having vesting periods ranging from immediate to three years. During~~during the ~~nine~~current period:

Unvested RSUs

Weighted

Average

Number of

Grant-date

Shares

Fair Value

shares in thousands
Unvested at December 31, 2019

951

$
2.15
Granted

2,696

$
0.70
Vested

(491)

$
2.36
Forfeited

(214)

$
1.11
Unvested at June 30, 2020

2,942

$
0.87

The fair value of RSUs that vested during the six months ended ~~September~~June 30, 2019, the Company issued stock option awards from the OIP for 600,000 shares having vesting periods of five and one-half to thirty-five months. During the nine months ended September 30, 2018, the Company issued stock option awards from the OIP for 1,131,841 shares to eligible individuals, with such stock option awards having vesting periods ranging from one to three years, and stock options issued to acquire 300,000 shares of Company common stock were scheduled to vest upon the attainment of various milestones. All restricted stock units were valued2020 was approximately $362 based on the stock price at the time of ~~the Company’s common~~vesting. As of June 30, 2020, unrecognized restricted stock ~~on the date~~compensation expense amounted to $2,059 which is expected to be recognized over a weighted average period of ~~the award and all~~approximately 1.94 years.
Stock Options. Our outstanding stock ~~option awards~~options were valued using the Black-Scholes option-pricing model on the date of the award.
For the three and nine months ended September 30, 2019, the Company recorded compensation expense related to restricted stock unit and stock option awards granted under the OIP of $1,440,225 and $2,405,881, respectively (stock option awards granted under the OIP of $472,833 and $2,718,937 for three and nine months ended September 30, 2018, respectively). During the third quarter of 2019, in connection with the Company’s recent management changes, certain existing stock options were modified with respect to vesting and exercise dates. The modifications to the stock options, in accordance with ASC 718, resulted in compensation expense in 2019 of approximately $741,000. In addition, restricted stock units and stock options issued to the Company’s new CEO resulted in compensation expense during the third quarter of approximately $224,000.
As of September 30, 2019, unrecognized compensation expense related to non-vested stock options amounted to approximately $4,035,000, which is expected to be recognized as follows: approximately $788,000, $1,677,000, $657,000 and $105,000 during 2019, 2020, 2021 and 2022, respectively. Approximately $808,000 of the unrecognized compensation expense relates to previously issued stock options, with the vesting of such stock options being based on the achievement of a certain milestones.
28
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The following assumptions were used for the nine months ended September 30, 2019 and 2018:
2019 2018
Risk-free interest rate (weighted average) 1.54 % 2.97 %
Expected dividend yield 0 % 0 %
Expected stock price volatility 70 % 90 %
Expected life of options (weighted average) 5.15 years 5.55 years
The Company estimated the expected volatility based on data used by a peer group of public companies. The expected term was estimated using the contract life of the option. The risk-free interest rate assumption was determined using yield of the equivalent U.S. Treasury bonds over the expected term. The Company has never paid any cash dividends and does not anticipate paying any cash dividends in the foreseeable future. Therefore, the Company assumed an expected dividend yield of zero.
A summary of all stock option activity since December 31, ~~2017~~2019 is as follows:

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Weighted
Weighted Average
Average Remaining Aggregate
Number of Exercise Contractual Intrinsic
Options Price Term Value
Outstanding at December 31, 2017 8,156,691 $ 1.28
Granted in 2018 1,631,841 2.64
Exercised in 2018 (612,259 ) 0.87
Expired / cancelled in 2018 (504,191 ) 1.71
Outstanding at December 31, 2018 8,672,082 1.54
Granted in 2019 600,000 2.07
Exercised in 2019 (75,410 ) 0.93
Forfeited in 2019 (909,500 ) 2.13
Outstanding at September 30, 2019 8,287,172 $ 1.52 5.9 years $ 6,808,227

Exercisable at September 30, 2019 6,182,688 $ 1.39 5.3 years $ 5,861,172

Weighted

Weighted

Average

Average

Remaining

Aggregate

Number of

Exercise

Contractual

Intrinsic


Options

Price

Term

Value

shares in thousands
Outstanding at December 31, 2019

7,837

$
1.49

Forfeited

(52)

$
2.28

Expired

(362)

$
1.43

Outstanding June 30, 2020

7,423

$
1.49

5.1
years
$
47

Exercisable at June 30, 2020

6,559

$
1.48

5.0
years
$
26

The intrinsic value of a stock option is the amount by which the current market value or the market value upon exercise of the underlying stock exceeds the exercise price of the option. As of June 30, 2020, unrecognized stock option compensation expense amounted to $204 which is expected to be recognized over a weighted average ~~grant date fair value~~period of approximately 0.7 years. In addition, there is approximately $637 of unrecognized stock ~~options issued during~~option compensation expense that requires the ~~nine months ended September 30, 2019~~achievement of certain milestones which have yet to be obtained.

Restricted Stock and ~~2018 was $2.07~~Stock Option Compensation Expense. The Company recognized the following compensation costs, net of actual forfeitures, related to restricted stock and ~~$1.80, respectively.~~ stock options:

Three Months Ended

Six Months Ended

June 30,

June 30,


2020

2019

2020

2019
Sales, general, and administrative

$
334

$
446

$
772

$
795
Research and Development

42

71

84

171
Total restricted stock and stock option compensation

$
376

$
517

$
856

$
966

NOTE 13. – REVENUE RECOGNITION
The ~~total fair value~~Company recognizes revenue when it satisfies a performance obligation by transferring control of ~~options that vested during~~ the ~~nine months ended September 30, 2019~~product to a customer. The Company’s customer contracts consist of obligations to manufacture the customer’s branded filtered cigars and ~~2018 amounted~~cigarettes. For certain contracts, the performance obligation is satisfied over time as the Company determines, due to ~~$2,279,810~~contract restrictions, it does not have an alternative use of the product, and ~~$2,392,207, respectively. There were 75,410 options exercised on a cashless basis during~~it has an enforceable right to payment as the ~~nine months ended September 30, 2019 resulting~~product is manufactured. The Company recognizes revenue under those contracts at the unit price stated in the ~~issuance of 39,988 shares~~contract based on the units manufactured. Revenue from the sale of the Company’s products is recognized net of cash discounts, sales returns and allowances. There was 0 allowance for discounts or returns and allowances at June 30, 2020 and December 31, 2019.
Contract Assets and Liabilities
Unbilled receivables (contract assets) represent revenues recognized for performance obligations that have been satisfied but have not been billed. These receivables are included as Accounts receivable, net on the Consolidated Balance Sheets. Customer payment terms vary depending on the terms of each customer contract, but payment is generally due prior to product shipment or within extended credit terms up to twenty-one (21) days after shipment. Deferred Revenue (contract liabilities) relate to down payments received from customers in advance of satisfying a performance obligation. This deferred revenue is included as Deferred income on the Consolidated Balance Sheets.

Table of Contents

Total contract assets and contract liabilities are as follows:

June 30,

December 31,


2020

2019
Unbilled receivables

$
164

$
406
Deferred Revenue

—

5
Net contract assets

$
164

$
401

Disaggregation of Revenue
The Company’s net sales revenue is derived from customers located primarily in the United States of America and is disaggregated by the timing of revenue recognition—net sales transferred over time and net sales transferred at a point in time. All revenue is related to contract manufacturing.

Three Months Ended

Six Months Ended

June 30,

June 30,


2020

2019

2020

2019

Net sales-over time

$
3,718

$
3,444

$
8,526

$
7,029

Net sales-point in time

2,717

2,371

4,967

5,080

Total Revenue

$
6,435

$
5,815

$
13,493

$
12,109

NOTE 14. – EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings (loss) per common ~~stock.There were 327,134 options exercised on a cash~~share for the three and ~~cashless basis during the nine~~six months ended ~~September~~June 30, ~~2018 resulting in~~2020 and June 30, 2019, respectively. Outstanding warrants, options, and restricted stock units were excluded from the ~~issuance~~calculation of ~~342,089 shares~~diluted EPS as the effect was antidilutive.

Three Months Ended

Six Months Ended

June 30,

June 30,


2020

2019

2020

2019

(in thousands)
Net loss

$
(5,057)

$
(8,042)

$
(9,086)

$
(10,115)
Weighted average common shares outstanding - basic and diluted

138,854

124,662

138,732

124,653
Net loss per common share - basic and diluted

$
(0.04)

$
(0.06)

$
(0.07)

$
(0.08)

Anti-dilutive shares are as follows:

Warrants

11,293

11,293

11,293

11,293
Options

7,423

7,703

7,423

7,703
Restricted stock units

2,942

693

2,942

693

21,659

19,689

21,659

19,689

Table of ~~the Company’s common stock and provided proceeds to the Company of $217,500 from such stock option exercises.~~ Stock options to purchase 900,000 shares of the Company common stock were not exercised by a former employee’s beneficiaries during the twelve-month period following his death and have subsequently been returned to the OIP.Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward Looking Statements
This Quarterly Report on Form 10-Q contains “forward-looking statements” that reflect, when made, the Company’s expectations or beliefs concerning future events that involve risks and uncertainties. Forward-looking statements frequently are identified by the words “believe,” “anticipate,” “expect,” “estimate,” “intend,” “project,” “will be,” “will continue,” “will likely result,” or other similar words and phrases. Similarly, statements herein that describe the Company’s objectives, plans or goals also are forward-looking statements. Actual results could differ materially from those projected, implied or anticipated by the Company’s forward-looking statements. Some of the factors that could cause actual results to differ include: our ability to monetize our intellectual property portfolio; our ability to achieve profitability; our ability to manage our growth effectively; the lack of implementation of the plan by the U.S. Food and Drug Administration (“FDA”) to regulate nicotine content in cigarettes; our ability to obtain FDA ~~clearance~~authorization for our Modified Risk Tobacco Product; our ability to gain market acceptance for our products; our ability to prevail in litigation; and our ability to maintain our rights to our intellectual ~~property.~~property and the impact of the outbreak of the coronavirus or another health pandemic or other global disaster on our business and operations. For a discussion of these and all other known risks and uncertainties that could cause actual results to differ from those contained in the forward-looking statements, see “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, ~~2018,~~2019 and Quarterly Report on Form 10-Q for the quarter ended March 31, 2020, which isare available on the SEC’s website at www.sec.gov. All forward-looking statements are qualified in their entirety by this cautionary statement, and the Company undertakes no obligation to revise or update this Quarterly Report on Form 10-Q to reflect events or circumstances after the date hereof.
For purposes of this Management’s Discussion and Analysis of Financial Condition and Results of Operations, references to the “Company,” “we,” “us” or “our” refer to the operations of 22nd Century Group, Inc. and its direct and indirect subsidiaries for the periods described herein.
Overview
We are a plant biotechnology company focused on ~~(i) developing reduced risk tobacco cigarettes~~technology that allows us to alter the level of nicotine and ~~smoking cessation products produced from modifying the nicotine content~~other nicotinic alkaloids in tobacco plants ~~through genetic engineering~~ and ~~plant breeding, and (ii) research and development~~the levels of ~~unique~~cannabinoids in hemp/cannabis plants through genetic engineering and modern plant breeding techniques. Our mission in tobacco is to ~~alter levels~~reduce the harm caused by smoking by introducing adult smokers to our proprietary, Very Low Nicotine Content (“VLNC”) tobacco and cigarette products. Our mission in hemp/cannabis is to develop proprietary varieties of ~~cannabinoids to be used for potential new medicines~~hemp with valuable cannabinoid profiles and ~~to improve~~ other superior agronomic ~~traits for improved agricultural applications.~~traits. We have a significant intellectual property portfolio of issued patents and patent applications relating to ~~the~~both tobacco and hemp/cannabis plants. ~~Our management team is focused on monetizing our intellectual property portfolio; facilitating the timely implementation of the plan by the FDA to require that~~~~all~~ combustible cigarettes sold in the United States contain only minimally or non-addictive levels of nicotine; working to obtain a reduced exposure marketing authorization from the FDA for our Modified Risk Tobacco Product (“MRTP”) application to the FDA for our Very Low Nicotine Content (“VLNC”) cigarettes to be marketed in the United States under the proposed product name of “VLN^®” cigarettes as containing 95% less nicotine than conventional tobacco cigarettes, and other related claims as may be approved by the FDA; seeking licensing agreements for our tobacco technology and/or our proprietary tobaccos; establishing international strategic partnerships to sell and distribute our proprietary tobacco and products; and developing and commercializing unique plant varieties of hemp for important new medicines and agricultural crops.
30
In tobacco, we have developed unique and proprietary bright and burley VLNC ~~tobacco~~tobaccos that ~~grows~~grow with at least 95% less nicotine than tobacco used in conventional ~~cigarette tobacco.~~cigarettes. In the year 2011, ~~our Company~~we developed ~~its~~our SPECTRUM^® research cigarettes in collaboration with independent researchers and officials from the FDA, the National Institute on Drug Abuse (“NIDA”), which is part of the National Institutes of Health (“NIH”), the National Cancer Institute (“NCI”), and the Centers for Disease Control and Prevention (“CDC”). Since 2011, we have ~~produced~~provided more than 28 million ~~SPECTRUM~~^®variable nicotine research cigarettes ~~containing our proprietary VLNC tobaccos~~ for use in numerous independent clinical studies ~~sponsored by agencies of the U.S. federal government. The main SPECTRUM~~^® product line consists of a series of cigarette styles that vary nicotine yields over a range – from very low (97% less nicotine than tobacco contained in conventional cigarette products) to relatively high nicotine yields. SPECTRUM^®~~features 24 styles, in both regular and menthol versions,~~ with ~~8 different levels of nicotine. To date, we estimate that~~ agencies of the United States federal government ~~have invested~~investing more than $125 million in such independent clinical ~~studies using our SPECTRUM~~^® ~~research cigarettes.~~studies. The results of these independent clinical studies ashave been published in peer-reviewed publications (including ~~but not limited to~~ theNew England Journal of Medicine, theJournal of the American Medical Association, and many others)~~, show that our proprietary~~. Our VLNC ~~cigarettes containing our unique VLNC tobacco are~~tobaccos have been associated ~~with: (1) reduced~~with reductions in smoking, ~~(2) lower~~ nicotine exposure ~~(3) increased quit attempts,~~ and ~~(4) lessened~~ nicotine dependence ~~all~~ with ~~minimal~~little to no evidence of ~~nicotine withdrawal symptoms,~~ compensatory smoking orand without serious adverse events. A list of completed and published clinical studies using cigarettes made with our ~~Company’s~~ VLNC ~~tobacco~~tobaccos is shown on ~~the Company’s~~our website at~~http:~~https://www.xxiicentury.com/~~published-clinical-studies/~~vln-clinical-studies/published-clinical-studies-on-very-low-nicotine-content-vlnc-cigarettes.
A list of on-going clinical studies using our ~~Company’s~~ SPECTRUM^® research cigarettes is shown on ~~the Company’s~~our website at~~http:~~https://www.xxiicentury.com/~~on-going-clinical-studies/~~vln-clinical-studies/on-going-clinical-studies-on-very-low-nicotine-content-vlnc-cigarettes. ~~The numerous independent clinical~~We do not incorporate third party studies or the information on ~~VLNC cigarettes provides the scientific foundation for the FDA’s announcement~~our website into this Quarterly Report on ~~July 28, 2017 that the FDA plans to require that all combustible cigarettes sold in the United States contain only minimally or non-addictive levels~~Form 10-Q.

Table of nicotine. On March 19, 2018, the FDA publicly announced its Advance Notice of Proposed Rulemaking (“ANPRM”) to solicit public comments on the FDA’s plan to enact a new nicotine reduction rule. On July 16, 2018, we publicly submitted to the FDA our formal written response to the ANPRM in which we described how (i) the FDA’s proposed new rule is supported by rigorous independent, published science, (ii) the FDA’s stated goal to render cigarettes minimally or non-addictive is immediately feasible as evidenced by our production and delivery of more than 28 million VLNC research cigarettes since the year 2011, and (iii) the FDA’s proposed new rule is exceedingly practical and urgently needed in the interests of public health. After we obtain all necessary regulatory approvals, we plan to offer our proprietary VLNC cigarettes for domestic sale, for international sale, and for licensing by third parties.Contents

In ~~hemp/cannabis,~~hemp, we are developing proprietary hemp ~~strains for important~~varieties with increased levels of certain cannabinoids and other desirable agronomic traits with the goal of generating new ~~medicines~~ and ~~agricultural crops.~~valuable intellectual property and plant lines. Our ~~current~~ activities in the United States involve only work with legal hemp in full compliance with U.S. federal and state laws. The hemp plant and the ~~cannabis/~~marijuana plant are both part of the samecannabis ~~sativa~~ ~~genus/species~~genus of plant, except that hemp has not more than 0.3% dry weight content of delta-9-tetrahydrocannabinol (“THC”). The federal Agricultural Improvement Act of 2018 (the “2018 Farm Bill”) legalized hemp and cannabinoids extracted from hemp in the U.S., but such extracts remain subject to state laws and ~~the~~ regulation by other U.S. federal agencies, such as the FDA and the U.S. Department of Agriculture (“USDA”). The same plant, with a higher THC content is ~~cannabis/~~marijuana, which is legal under certain state laws, but which is currently not legal under U.S. federal law. WeThe similarities between these plants can cause confusion. To reflect this difference in law, sometimes we refer to legal hemp and the legal hemp industry as hemp/cannabis to distinguish this as being separate and apart from marijuana/cannabis which is not legal under U.S. federal law. Our activities with legal hemp have sometimes been incorrectly perceived as us being involved in federally illegal marijuana/cannabis. This is not the case. In the United States, we work only with legal hemp in full compliance with federal and state laws. We have developed hemp plants with agronomically desirable traits for commercial uses and/or unique cannabinoid levels for possible extraction purposes. We believe that we have many types of superior and unique hemp plant varieties, including (i) hemp plants with low to no amounts of THC and other desirable agronomic traits for the legal hemp industry and (ii) hemp plants with high levels of cannabidiol (“CBD”) and other non-THC cannabinoids for the legal medical cannabinoid markets. In the United States, we have worked with the University of Virginia (“UVA”) to (i) create unique industrial hemp plants with levels of THC below 0.3%, which is the legal limit that defines hemp for optimal growth in Virginia, (ii) optimize other desirable hemp plant characteristics to improve the plant’s suitability for growing in Virginia and in similar legacy tobacco regions of the United States, and (iii) utilize high-value medical cannabinoid hemp varieties for use in human therapeutics. We have also obtained a license in the State of New York to research and grow hemp in that state. In Canada, we previously conducted sponsored research on the hemp plant with Anandia Laboratories in Vancouver, British Columbia, in full compliance with Canadian regulations. In Europe and the United States, we are working with KeyGene NV, global leader in plant research involving high-value genetic traits and increased crop yields, in an exclusive, worldwide collaboration that will focus on developing hemp/cannabis plants with exceptional cannabinoid profiles and other superior agronomic traits for medical, therapeutic and agricultural uses, among many other applications.

During the third quarter of 2019, in connection with our recent management changes, we decided on a going-forward basis that we will be concentrating our business and scientific resources, personnel and efforts on the portion of our intellectual property portfolio (patents, patent applications and trademarks) that relate to very low nicotine tobacco plants and potential products, as well as unique hemp/cannabis plants and potential products, in order to more strategically pursue our objectives. Accordingly, during the third quarter of 2019, we recorded a non-cash impairment charge of $1,142,349 related the portions of our intellectual property portfolio that are no longer areas of our focus on a going-forward basis. The non-cash impairment charge relates to the portion of our intellectual property portfolio relating to increased nicotine in tobacco; potentially reduced exposure products involving higher nicotine products; older scientific methods of working with genes in tobacco plants; methods of utilizing the biomass of tobacco plants; and trademarks that do not fit within the types of products that we desire to commercialize in the future. We further decided on a going-forward basis to narrow the countries in which we will support our intellectual property filings to more strategically focus on protecting our intellectual property in countries that are scientifically or commercially of highest importance rather than a broader focus. We intend to continue to review and refine our business and scientific focus, resources and efforts in the future in order to continue to strategically pursue our objectives in cost-effective ways. We also believe that certain portions of our intellectual property portfolio that we will not be utilizing in the future nevertheless still have value, so we will be investigating potential opportunities to out-license to third-parties those portions of our intellectual property portfolio that we will not be utilizing in the future, but which may be desirable by third-parties.

Additional information about our business and operations is contained in our Annual Report on Form 10-K for the year ended December 31, ~~2018. Information~~2019.

COVID-19 Pandemic

The COVID-19 pandemic has caused some disruption to our business and poses a risk to our future business, including delays by third party providers of goods or services to our business, interruptions to our sales, research and development, and administrative activities, and disruptions to our manufacturing operations. Similarly, state or federal authorities may also be affected in their capacity or capability to operate as normal and may impact the timeline of product authorizations which may disrupt our business plans.

Our Williamsville, NY corporate re-opened in June and our R&D laboratory in Buffalo, NY re-opened in May and are currently operating under strict safety protocols in accordance with New York State’s reopening guidelines. These protocols include physical distancing, mandatory face coverings, disinfection of surfaces, and other health and safety measures. We continue to encourage remote work arrangements by any and all employees where job duties permit. Although our laboratory in Buffalo reopened in May, some of our external research and development partners were either closed or operating on a modified or limited schedule during the height of the pandemic. The temporary closure of our laboratory and the interruption to our workflow related to COVID-19 have impacted our internal and external laboratory research operations. Our executive leadership team and staff are continuously monitoring this ever-evolving situation and its impacts on our ~~website including, but not limited~~business.

Our NASCO production facility in North Carolina remains open, having been classified as an essential business as it is part of the supply chain for grocery stores and convenience stores. Despite the pandemic, we have been able to ~~third party clinical studies, is not incorporated by reference into this Form 10-Q.~~fulfill sales orders in a timely manner. The safety and well-being of our employees remains a top priority and we to continue monitor and operate in line with local, state, and federal safety guidelines. An outbreak at our production facility, or disruption in our supply chain, could cause us to slow or temporarily cease our manufacturing operations.

We will continue to monitor the local, state and federal guidance regarding our business practices.

~~Strategic Objectives~~Second Quarter 2020 Business Highlights and Notable Events:

~~Our strategic objectives include~~Key highlights for the ~~following:~~

~~Facilitating the implementation of the plan announced by the FDA to require that~~~~all~~ ~~combustible cigarettes sold in the United States contain only minimally or non-addictive levels of nicotine;~~

Continuing to work with the FDA on our MRTP application that we have submitted to the FDA to obtain a reduced exposure marketing authorization for our VLNC cigarettes to be marketed in the United States under the proposed product name of “VLN^®~~” as containing 95% less nicotine than conventional tobacco cigarettes, and other related claims as may be approved by the FDA;~~

~~Seeking licensing agreements for our VLNC tobacco technology and/or our VLNC proprietary tobaccos;~~

~~Continuing to produce~~~~SPECTRUM~~^® ~~research cigarettes for the National Institute on Drug Abuse (“NIDA”), which is part of the National Institutes of Health (“NIH”), for use in independent clinical studies;~~

~~Continuing to research and develop other novel VLNC tobacco plant varieties;~~

~~Continuing to explore opportunities outside of the United States for the use of our VLNC tobacco in foreign countries that may desire such products;~~

Continuing to expand our legal hemp/cannabis activities and development of unique plant varieties of hemp, including (i) hemp plants with other desirable agronomic traits in addition to low to no amounts of THC for the legal hemp industry, and (ii) hemp plants with high levels of CBD and other non-THC cannabinoids for the legal medical cannabinoid markets;

second quarter 2020

·●

~~We plan~~Net sales revenue increased 11% to ~~opportunistically create shareholder value through partnerships, investments~~$6.4 million dollars.

●

Gross profit continues to show improvement year-over-year, demonstrating the success of targeted actions to improve margins and ~~other strategic relationships across the entire hemp/cannabis value chain, including branded consumer products;~~cost structure.

●

Operating loss improved by approximately $276 thousand.

●

Appointed a new CEO, James A. Mish and new CFO, John Franzino

~~Continuing to seek additional customers to increase our contract manufacturing business for third-party branded tobacco products.~~

~~For the third quarter of 2019, we announced:~~

On ~~July 12, 2019,~~June 3, 2020, we announced James A. Mish as our new CEO, effective June 22. Mish brings executive leadership experience in science-driven organizations. His most recent professional experience includes the ~~publication~~development, manufacturing, and

Table of Contents

commercialization of active pharmaceutical ingredients, including cannabinoids, and related consumer products. He has an outstanding track record of delivering profitable growth at both privately held and publicly traded companies.

We also announced John Franzino as our new CFO, effective June 3, 2020. John is an accomplished strategic financial executive with a ~~report by~~track record of successful leadership in high-growth, highly regulated, consumer-facing industries including tobacco and alcoholic beverages.

During the ~~Centers~~quarter, the public comment period for ~~Disease Control and Prevention~~our Modified Risk Tobacco Product (“~~CDC”~~MRTP”) ~~that found 8 out of 10 adults in~~Application for VLN^® closed on May 18, 2020. The application requests a modified exposure marketing authorization from the ~~United States are in favor of lowering~~FDA to market our reduced nicotine ~~levels in cigarettes. The CDC survey was conducted in 2018 and assessed adults’ attitudes toward regulating nicotine levels in~~content tobacco cigarettes in the U.S., with the survey reflecting that an overwhelming majority of adults, including 80% of cigarette smokers and 84% of former smokers, favored requiring cigarette makers to lower the nicotine levels in cigarettes to make them less addictive, with the high level of favorable support by adults in the U.S. being consistent across all assessed sociodemographic factors in the survey, including sex, age, income, education, and race/ethnicity. In such CDC survey, the Director of CDC’s Office on Smoking and Health, Corinne Graffunder, Dr.PH., M.P.H., stated that “Cigarettes and other combustible tobacco products are responsible for the overwhelming burden of death and disease from tobacco use in the United States. Lowering nicotine levels in cigarettes could help current smokers quit and make it less likely for future generations to become addicted to these products.”

~~On July 19, 2019, we announced that the FDA accepted and filed for substantive scientific review our MRTP application for our VLNC cigarettes~~ under the proposed brand name of VLN^®, with product labeling and advertising claims stating that VLN^® has 95% less nicotine than conventional cigarettes as well as other claims related to reduced nicotine exposure. The closing of the public comment period is an important milestone in the FDA’s ongoing scientific review of our MRTP Application, which ~~are made~~seeks permission to market our reduced nicotine content cigarettes to adult smokers with the aforementioned product claims.

On April 30, 2020, we announced that, in collaboration with our ~~proprietary~~research partner North Carolina State University (“NCSU”), we had completed research field trials that have validated new non-GMO (genetically modified organism) methodologies for reducing nicotine in tobacco plants. The research was funded by us and was conducted by NCSU’s Department of Crop and Soil Science with project oversight provided by our R&D team. During the quarter, we also completed plantings of non-GMO VLNC tobacco ~~and, as a result, contain very low levels~~plant lines for multi-site, field trials to optimize growing practices of ~~nicotine. The MRTP application is now moving forward~~our non-GMO, VLNC plant lines in anticipation of the commercialization of these new lines in the ~~next phase~~U.S. and internationally.

Despite the COVID-19 pandemic, we were able to complete a sizeable portion of our research and development program in hemp/cannabis and have recently sequenced more than 250 additional plant lines. We continue to expand our knowledge foundation and bolster the information in our proprietary hemp/cannabis bioinformatics platform. The data will help us analyze and advance our understanding of the ~~FDA review process.~~

~~Effective August 3, 2019,~~hemp/cannabis plant and enable us to identify the ~~Board~~genes and biosynthetic pathways responsible for the modulation and production of ~~Directors of the Company appointed Clifford B. Fleet as President~~various cannabinoids and Chief Executive Officer of the Company. In addition, Mr. Fleet was appointed to the Company’s Board of Directors as a Class I Director for a term to expire in 2021. Mr. Fleet has served as a strategic advisor to the Company since December 2018. Prior to such time, Mr. Fleet served as the President and Chief Executive Officer of Philip Morris USA (“PM USA”) from 2013 to 2017, where he oversaw PM USA and John Middleton, a leading manufacturer of machine-made cigars. Since departing PM USA in 2017, Mr. Fleet has supported numerous businesses and non-profits as a Managing Partner at SIR, a strategic management consultancy based in Richmond, Virginia.

~~Subsequent to the close of the third quarter of 2019, our accomplishments and notable events include:~~

~~On October 21, 2019, following an industry-wide cigarette price increase, we announced an increase~~terpenes in the ~~pricing of third-party cigarette products sold by the Company to its contract manufacturing customers. As a result of~~plant. Through this ~~price increase, the Company expects to improve its gross margin performance for cigarettes.~~

On October 24, 2019, John Pritchard, the Company’s Vice President of Regulatory Science presented at the Food and Drug Law Institute’s Tobacco and Nicotine Products Regulation and Policy Conference in Washington, DC. The presentation, part of a panel session entitled “Reading the Tobacco Leaves: Paths and Challenges for a Nicotine Reduction Rule,” addressed the potential scope and nicotine level of the FDA’s proposed reduced nicotine product standard and its technical feasibility.

~~Through our partnership with KeyGene,~~work, we ~~completed a deep analysis of~~have already identified several hemp/cannabis lines ~~established~~that exhibit distinctive levels of key cannabinoids, and ~~expanded a proprietary cannabis genomic database, began~~ the ~~sequencing and development of high-quality de novo assemblies of several hemp/cannabis~~associated genetic markers that will allow us to breed stable plant lines for commercial use. Additional investigation and ~~developed novel laboratory analysis techniques. These activities~~research will ~~facilitate our on-going hemp/cannabis research efforts focused on developing hemp/cannabis plants~~be carried out to under the mechanisms behind these distinctive traits and to identify the candidates with ~~exceptional cannabinoid profiles~~the greatest commercial value.

Results of Operations

Dollar Amounts in Thousands ($000’s), except for per-share data

Three and ~~other superior agronomic traits for medical, therapeutic and agricultural uses.~~

The Company entered the final phase of the harvesting and curing of our 2019 crop of our proprietary VLNC tobacco. This tobacco has been grown in anticipation of FDA’s authorization of the Company’s MRTP application for our VLNC cigarettes. Upon authorization, we plan to begin test marketing of our VLNC cigarettes in selected geographies in the U.S.

The Company recently concluded several field trials of our non-GMO, bright and burley, VLNC tobacco lines. In independent testing, these lines have shown nicotine reductions of up to 98% compared to conventional cigarette tobaccos. The Company plans to continue field trials in support of the anticipated commercialization of its proprietary VLNC cigarettes and in support of the implementation of the FDA’s proposed reduced nicotine product standard.

As part of its on-going strategic cost alignment efforts, the Company has taken broad-based actions to reduce expenses across many areas of the Company including employee headcount reductions and legal expense reductions related to the discontinuation of non-strategic patent and trademark maintenance.

~~Three~~Six Months Ended ~~September~~June 30, ~~2019~~2020 Compared to Three and Six Months Ended ~~September~~June 30, ~~2018~~2019

Revenue - Sale of products, net

Quarter-to-Date

Year-to-Date

June 30

June 30

June 30

June 30


2020

2019

2020

2019
Sale of products, net

$
6,435

$
5,815

$
13,493

$
12,109
Dollar Change from Prior Year

620



1,384

Percentage Change from Prior Year

10.7
%



11.4
%

In the three months ended September 30, 2019, we realized net sales revenue from the sale of products in the amount of $6,461,914, an increase of $201,756, or 3.2%, from net sales revenue of $6,260,158 for the three months ended September 30, 2018.
The increase in ~~net~~ sales revenue for the ~~third~~second quarter of ~~2019~~2020 was primarily the result of an increase in the sales of contract manufactured ~~cigarettes of $208,000, as compared to~~filtered cigars in the ~~third quarter of 2018 and a net increase in other miscellaneous sales activity~~amount of approximately ~~$146,000, partially~~$800, which was driven by a mix of increased unit sales and price increases. This increase was offset by a ~~decrease~~$200 decline in ~~the production~~contract manufactured cigarette sales. Year-to-date through June 30, 2020, sales of contract manufactured filtered cigars ~~where revenue is recognized over time~~and cigarettes increased approximately $974 and $400, respectively, from the year-to-date period ended June 30, 2019 and were also influenced by higher sales and unit price increases.

Table of ~~approximately $152,000, as compared to the third quarter of 2018.~~Contents

Cost of goods sold - Products / Gross profit (loss) ~~profit~~

Quarter-to-Date

Year-to-Date

June 30

June 30

June 30

June 30


2020

2019

2020

2019

Cost of goods sold

$
6,234

$
5,901

$
13,005

$
12,298

Percent of Product Sales

96.9
%

101.5
%

96.4
%

101.6
%
Dollar Change from Prior Year

333



707

Percentage Change from Prior Year

5.6
%



5.7
%

~~During~~

Quarter-to-Date

Year-to-Date

June 30

June 30

June 30

June 30


2020

2019

2020

2019

Gross profit (loss)

$
201

$
(86)

$
488

$
(189)

Percent of Product Sales

3.1
%

(1.5)
%

3.6
%

(1.6)
%
Dollar Change from Prior Year

287



677

For the three and six months ended June 30, 2020, the change to a Gross profit from a Gross loss for the comparable prior year period was driven by lower Cost of goods sold. Cost of goods sold declined to 96.9% of revenue during the three months ended ~~September~~June 30, ~~2019, cost~~2020 from 101.5% of ~~goods sold were $6,482,982, or 100.3%,~~revenue for the quarter ended June 30, 2019. Gross margin improvement during the quarter and year-to-date periods was the result of ~~net sales revenue, resulting in a gross loss on sales of products in~~price increases and lower labor and overhead costs per unit driven by factory efficiencies implemented over the amount of $21,068. During the three months ended September 30, 2018, cost of goods sold were $6,109,209, or 97.6%, of net sales revenue, resulting in a gross profit on sales of products in the amount of $150,949. The negative change from a gross profitlast six months.
Research and development expense

Quarter-to-Date

Year-to-Date

June 30

June 30

June 30

June 30


2020

2019

2020

2019

Research and Development

$
957

$
1,674

$
1,770

$
2,914

Percent of Product Sales

14.9
%

28.8
%

13.1
%

24.1
%
Dollar Change from Prior Year

(717)



(1,144)

Percentage Change from Prior Year

(42.8)
%



(39.2)
%

Lower R&D expense for the three months ended ~~September~~June 30, ~~2018~~2020 was driven by a $379 decrease in our R&D Personnel expense, and a $313 decrease in our R&D Contract costs compared to ~~a gross loss for~~ the three months ended ~~September~~June 30, ~~2019~~2019. Lower R&D expense for the six months ended June 30, 2020 was ~~primarily the result~~driven by a decrease in R&D Personnel expense of ~~additional expenses incurred during the third quarter~~$618, and a decrease in R&D contract costs of ~~2019, as~~$471 compared to the ~~third quarter~~six months ended June 30, 2019. Lower R&D spending for the three and six months ended June 30, 2020 is not reflective of ~~2018. The additional expenses consisted primarily of (1) an increase~~a change in fees due to the FDA on filtered cigars of approximately $91,000, and (2) an increase in manufacturing expenses, primarily related to labor, charged to the cost of goods sold during the third quarter of 2019, as compared to the third quarter of 2018.
~~Research and development expense~~
our R&D investment priorities.
Research and development ~~(“R&D”)~~ expense ~~was $1,992,687 in~~- MRTP

Quarter-to-Date

Year-to-Date

June 30

June 30

June 30

June 30


2020

2019

2020

2019

Research and Development - MRTP

$
4

$
313

$
154

$
1,524

Percent of Product Sales

0.1
%

5.4
%

1.1
%

12.6
%
Dollar Change from Prior Year

(308)



(1,370)

Percentage Change from Prior Year

(98.6)
%



(89.9)
%

Table of Contents

Lower MRTP expenses for both the ~~three months~~quarter and year-to-date periods ended ~~September~~June 30, ~~2019, a decrease of $2,017,121, or 50.3%, from $4,009,808 in the three months ended September 30, 2018. This decrease was primarily a decrease in costs relating to~~2020 declined significantly, as we submitted our MRTP application ~~with~~to the FDA during 2019. MRTP-related expenses for the three and six months ended June 30, 2020 are primarily related to our VLNC cigarettes of approximately $3,080,000, a decrease in equity-based compensation expense of approximately $83,000, a decrease in payroll and related benefits of approximately $58,000 , partially offset by the write-down of obsolete tobacco leaf inventory of approximately $882,000, an increase in sponsored research costs of approximately $275,000 and a net increase in various other R&D expenses of approximately $47,000.

~~Sales, general and administrative expense~~

February 14, 2020 Tobacco Products Scientific Advisory Committee (TPSAC) hearing.

Sales, general and administrative expense ~~was $4,059,005~~

Quarter-to-Date

Year-to-Date

June 30

June 30

June 30

June 30


2020

2019

2020

2019

Sales, general and administrative

$
3,501

$
2,586

$
6,640

$
5,060

Percent of Product Sales

54.4
%

44.5
%

49.2
%

41.8
%
Dollar Change from Prior Year

915



1,580

Percentage Change from Prior Year

35.4
%



31.2
%

The increase in Sales, general and administrative (“SG&A”) expense during the three months ended ~~September~~June 30, ~~2019, an~~2020 was driven by a $497 increase ~~of $2,061,047, or 103.2%, from $1,997,958~~ in Consulting & Professional services expenses, a $428 increase in Insurance expenses, a $306 increase in Severance expense, and a $74 increase in accounting fees compared to the three months ended ~~September~~June 30, ~~2018.~~2019. These increases were partially offset by a $200 decrease in legal fees, a $132 decrease in Investor Relations costs, a $91 decrease in SG&A Travel and Entertainment expenses. The ~~increase was mainly due to an~~year-to-date increase in ~~equity-based compensation of approximately $1,050,000, severance~~SG&A expense ~~of approximately $721,000, an~~through June 30, 2020 was driven by a $738 increase in ~~payroll and related benefits of approximately $437,000, and an~~Consulting & Professional services expenses, a $496 increase in ~~business insurance costs of approximately $105,000,~~SG&A Personnel expense, a $469 increase in Insurance expenses, and a $306 increase in one-time Severance expense. We have deployed this incremental SG&A spending to support our corporate management capabilities, and to evaluate and prepare for future opportunities. These increases were partially offset by a decrease in Investor Relations expenses ~~relating to investor relations~~ of ~~approximately $82,000,~~$121, a decrease in SG&A Travel and Entertainment expenses of $116, and a decrease in legal ~~and accounting~~ fees of ~~approximately $49,000,~~$65 for the year-to-date period ended June 30, 2020 as compared to the same period in 2019.
Impairment expense

Quarter-to-Date

Year-to-Date

June 30

June 30

June 30

June 30


2020

2019

2020

2019

Impairment of intangible assets

$
146

$
—

$
146

$
—

Percent of Product Sales

2.3
%

—
%

1.1
%

—
%
Dollar Change from Prior Year

146



146

During the second quarter of 2020, management conducted a ~~decrease in consulting fees~~review of intellectual property assets, and determined that impairment was required for certain patent costs that would be expired before the Company planned to commercialize. As such, we recorded a one-time impairment expense of approximately ~~$22,000, and a net decrease in various other sales, general and administrative expenses of approximately $99,000.~~$146.
34

~~Impairment~~Depreciation expense

Quarter-to-Date

Year-to-Date

June 30

June 30

June 30

June 30


2020

2019

2020

2019

Depreciation

$
157

$
147

$
313

$
282

Percent of Product Sales

2.4
%

2.5
%

2.3
%

2.3
%
Dollar Change from Prior Year

10



31

Percentage Change from Prior Year

6.9
%



10.9
%

The ~~non-cash impairment charge for the three months ended September 30, 2019 amounted to $1,142,349 related to the portion of our intellectual property portfolio relating to increased nicotine~~increase in tobacco; potentially reduced exposure products involving higher nicotine products; older scientific methods of working with genes in tobacco plants; methods of utilizing the biomass of tobacco plants; and trademarks that do not fit within the types of products that we desire to commercialize in the future. We incurred no impairment for the three months ended September 30, 2018.
Depreciation expense
~~Depreciation expense for the three months ended September 30, 2019 amounted to $157,653, an increase of $24,808, or 18.7%, from $132,846 for the three months ended September 30, 2018. The increase~~ was primarily due to ~~an increase in depreciable assets as a result~~additional Machinery and Equipment acquisitions during 2019, which primarily supported the build-out of ~~acquisitions~~our VLNC tobacco processing capabilities.

Table of machinery and equipment during the year ended December 31, 2018 and the nine months ended September 30, 2019 in the aggregate amount of approximately $967,000 primarily consisting of equipment additions in our NASCO factory operations in North Carolina.Contents

Amortization expense

Quarter-to-Date

Year-to-Date

June 30

June 30

June 30

June 30


2020

2019

2020

2019

Amortization

$
189

$
223

$
361

$
438

Percent of Product Sales

2.9
%

3.8
%

2.7
%

3.6
%
Dollar Change from Prior Year

(34)



(77)

Percentage Change from Prior Year

(15.1)
%



(17.7)
%

Amortization ~~expense for the three months ended September 30, 2019 amounted to $232,753, an increase of $13,582, or 6.2%, from $219,171 for the three months ended September 30, 2018. The amortization~~ expense relates to amortization taken on capitalized patent costs and license fees. The ~~increase~~decrease was primarily due to amortization ~~taken~~expense on ~~additional~~a lower patent ~~costs~~base which resulted from one-time impairment charges of $1,142 incurred during the ~~nine months~~quarter ended September 30, ~~2019 and the year ended December 31, 2018 of approximately $598,000 and $809,000, respectively.~~2019.

Unrealized gain (loss) ~~gain~~ on investment

Quarter-to-Date

Year-to-Date

June 30

June 30

June 30

June 30


2020

2019

2020

2019

Unrealized gain (loss) on investments

$
312

$
(1,424)

$
(133)

$
1,549

Percent of Product Sales

4.9
%

(24.5)
%

(1.0)
%

12.8
%
Dollar Change from Prior Year

1,736



(1,682)

Percentage Change from Prior Year

(121.9)
%



(108.6)
%

The warrants to purchase ~~973,971~~81,164 shares of Aurora Cannabis, Inc (“Aurora”) common stock ~~described in Note 4 to our consolidated financial statements,~~ are considered an equity security and are recorded at fair value. During the second quarter of 2020, Aurora announced a 12-to-1 reverse stock split which adjusted our total warrants to 81,164 (from 973,971). We recorded the fair value of the stock warrants of ~~$1,682,048~~$540 at ~~September~~June 30, 2019, using the Black-Scholes pricing model, and recorded an unrealized loss on the warrants in the amount of $2,959,898 for the three months ended September 30, 2019. The unrealized loss was primarily due to a decrease in the underlying stock price of Aurora’s common stock.
~~The Company recorded the fair value of these stock warrants of $6,731,114 at September 30, 2018,~~2020, using the Black-Scholes pricing model, and recorded an unrealized gain on the warrants in the amount of ~~$3,923,156~~$312 for the three months ended ~~September~~June 30, ~~2018.~~ 2020, and an unrealized loss of $133 for the six months ended June 30, 2020.
35
Gain on the sale of machinery and equipment
~~Realized gain~~

Quarter-to-Date

Year-to-Date

June 30

June 30

June 30

June 30


2020

2019

2020

2019

Gain on the sale of machinery and equipment

$
—

$
—

$
—

$
87

Percent of Product Sales

—
%

—
%

—
%

0.7
%
Dollar Change from Prior Year

—



(87)

Percentage Change from Prior Year

—
%



(100.0)
%

We did not realize any gains on ~~investments~~
~~There was no realized gain on investments~~the sale of Machinery and equipment during the three and six months ended ~~September~~June 30, ~~2019.~~
We held a 14.8% equity investment in Anandia. On August 8, 2018, all of Anandia’s outstanding common stock was acquired by Aurora in exchange for (i) free trading shares of Aurora common stock, and (ii) warrants with a five-year term to purchase one half of a share of Aurora common stock for each whole share of Aurora common stock received as part of2020. During the transaction. As a result of the transaction, we received 1,947,943 shares of Aurora common stock and warrants to purchase 973,971 shares of Aurora common stock that had a fair value at closing of $9,221,594 and $2,807,958, respectively. The Company recorded a realized gain on the transaction in the amount of $4,515,971 during the threesix months ended ~~September~~June 30, ~~2018. Subsequent to the transaction,~~2019, we sold ~~all~~a piece of machinery and equipment no longer required in our ~~Aurora common stock resulting~~factory operations in ~~net sales proceeds $13,051,503~~North Carolina and ~~realized~~recorded a gain on the sale ~~of $3,829,909. The aggregate realized gains from the Anandia transaction and the sale of the Aurora shares amount to $8,345,880 for the three months ended September 30, 2018.~~
~~Realized gain (loss) on short-term investment securities~~
~~We maintain a short-term investment account to invest our excess cash. Investments~~ in the ~~short-term investment account are managed in accordance with our investment policy. We realized a gain (loss) on short-term investment securities~~amount of ~~$90,489 and ($6,272) for the three months ended September 30, 2019 and 2018, respectively, resulting from the maturity of various debt instruments held in the short-term investment account.~~$87.
Interest income, net

Quarter-to-Date

Year-to-Date

June 30

June 30

June 30

June 30


2020

2019

2020

2019

Interest Income, net

$
462

$
243

$
1,074

$
515

Percent of Product Sales

7.2
%

4.2
%

8.0
%

4.3
%
Dollar Change from Prior Year

219



559

Percentage Change from Prior Year

89.9
%



108.4
%

Table of Contents

Interest income, net for the three months ended September 30, 2019, was $242,003, a decrease of $13,152, or 5.2%, from interest income of $255,155 for the three months ended September 30, 2018. The decrease in net interest income (interest income less investment fees) ~~was primarily~~for the ~~result~~quarter ended June 30, 2020 is made up of ~~a lower average balance~~approximately $97 interest accreted on our convertible note and preferred stock investment in Panacea, interest income accrued on the convertible note receivable of approximately $175, and net interest income earned on our short-term investment account ~~during~~of approximately $190. Interest income, net (interest income less investment fees) for the ~~three months~~year-to-date period ended ~~September~~June 30, 2020 is made up of approximately $306 interest accreted on our convertible note and preferred stock investment in Panacea, interest income accrued on the convertible note receivable of approximately $347, and net interest income earned on our short-term investment account of approximately $421. During 2019, ~~as compared to the average balance during the three months ended September 30, 2018.~~interest income was composed exclusively of earnings on our short-term investments.

Interest expense

Quarter-to-Date

Year-to-Date

June 30

June 30

June 30

June 30


2020

2019

2020

2019

Interest Expense

$
(19)

$
(13)

$
(31)

$
(24)

Percent of Product Sales

(0.3)
%

(0.2)
%

(0.2)
%

(0.2)
%
Dollar Change from Prior Year

(6)



(7)

Percentage Change from Prior Year

49.4
%



31.5
%

Interest expense was ~~$12,795~~in line with the expense for the ~~three months ended September 30, 2019, an increase of $8,364, or 188.8% from interest~~same quarter during prior year. Interest expense ~~of $4,431 and was derived from~~includes the accretion of interest on notes payable to NCSU and the University of Kentucky, ~~and~~ interest accretion on accrued ~~severance. We had no~~severance, and interest ~~expense related to University of Kentucky~~on notes payable for ~~the three months ended September 30, 2018.~~D&O insurance.

Net ~~(loss) income~~loss

Quarter-to-Date

Year-to-Date

June 30

June 30

June 30

June 30


2020

2019

2020

2019

Net Loss

$
(5,057)

$
(8,042)

$
(9,086)

$
(10,115)

Percent of Product Sales

(78.6)
%

(138.3)
%

(67.3)
%

(83.5)
%
Dollar Change from Prior Year

2,985



1,029

Percentage Change from Prior Year

(37.1)
%



(10.2)
%

~~We had a~~The decrease in net loss for the three months ended ~~September~~June 30, ~~2019 of $10,245,717 as~~2020 compared to ~~net income of $6,304,654 in~~ the ~~three months ended September 30, 2018. The negative change from net income to a net loss in~~same period during the ~~amount of $16,550,371~~prior year was primarily the result of ~~the one-time realized gain~~an unrealized loss of $1,424 on ~~investments relating to the Anandia/~~our Aurora ~~transactions~~warrants during the ~~third quarter~~three months ended June 30, 2019, which turned to an unrealized gain of ~~2018 of approximately $8,346,000, a negative change in~~$312 for the ~~unrealized (loss) gain on investment~~three months ended June 30, 2020, along with ~~respect to the Aurora stock warrants of approximately $6,883,000,~~ an increase in gross profit, lower total operating expenses, one-time Litigation Settlement expenses of ~~approximately $1,225,000,~~$1,890 during the second quarter of 2019 which were not repeated in 2020, and the ~~negative change~~interest income associated with our convertible note and preferred stock investment in Panacea. The year-to-date reduction in the net loss was the result of improved gross ~~(loss)~~ profit, ~~on sales of product of approximately $172,000, partially~~lower total operating expenses, and Panacea-related interest income. These impacts were somewhat offset by an ~~increase~~impairment charge on our Panacea stock warrant in the amount of $1,062 (see Note 5), and a net ~~other income (expense) items~~unrealized loss on our Aurora warrants in the amount of ~~approximately $75,000.~~
36
~~Other comprehensive income –~~in the amount of $133, which was an unrealized gain ~~(loss) on short-term investment securities~~of $1,549 for the year-to-date period ended June 30, 2019.

Quarter-to-Date

Year-to-Date

June 30

June 30

June 30

June 30


2020

2019

2020

2019

Other Comprehensive Income

$
238

$
17

$
45

$
180

Percent of Product Sales

3.7
%

0.3
%

0.3
%

1.5
%
Dollar Change from Prior Year

221



(135)

Percentage Change from Prior Year

1264.3
%



(74.7)
%

We maintain an account for short-term investment securities that are classified as available-for-sale securities and consist of money market funds, and corporate bonds ~~U.S. government agency bonds, and U.S. treasury securities~~ with maturities greater than three months at the time of acquisition. Unrealized gains and losses on short-term investment securities (the adjustment to fair value) are recorded as Other comprehensive income or loss. We recorded an unrealized gain on short-term investment securities in the amount of ~~$3,032~~$241 and recorded a reclassification of gains to net loss in the amount of ~~$90,489,~~$3, resulting in other comprehensive ~~loss in the amount~~income of ~~$87,457~~$238 for the three months ended ~~September~~June 30, ~~2019.~~2020. For the three months ended ~~September~~June 30, ~~2018,~~2019, we recorded an unrealized gain on short-term investment securities ~~in the amount~~ of ~~$33,386~~$89 and recorded a ~~reclassification~~

Table of ~~losses to net income in the amount of $6,272 resulting in other comprehensive income in the amount of $39,658.~~Contents

~~Nine months ended September 30, 2019 Compared to Nine months ended September 30, 2018~~

~~Revenue - Sale of products, net~~

In the nine months ended September 30, 2019, we realized net sales revenue from the sale of products in the amount of $18,570,541, a decrease of $720,569, or 3.7%, from net sales revenue of $19,291,110 for the nine months ended September 30, 2018. The decrease in net sales revenue for the first nine months of 2019 was primarily the result of a decrease in revenue from the production of filtered cigars where revenue is recognized over time of approximately $987,000, partially offset by an increase in contract manufactured cigarettes of approximately $143,000 and a net increase in other miscellaneous sales activity of approximately $123,000, as compared to the first nine months of 2018.

~~Cost of goods sold - Products / Gross (loss) profit~~

During the nine months ended September 30, 2019, cost of goods sold were $18,780,819, or 101.1%, of net sales revenue, resulting in a gross loss on sales of products in the amount of $210,278. During the nine months ended September 30, 2018, cost of goods sold were $18,906,869, or 98.0%, of net sales revenue, resulting in a gross profit on sales of products in the amount of $384,241. The negative change from a gross profit for the nine months ended September 30, 2018 to a gross loss for the nine months ended September 30, 2019 was primarily the result of additional expenses incurred during the first nine months of 2019, as compared to the first nine months of 2018. The additional expenses consisted primarily of (1) an increase in fees due to the FDA on filtered cigars of approximately $304,000, and (2) an increase in manufacturing expenses, primarily relating to labor and equipment maintenance costs during the nine months ended September 30, 2019, as compared to the nine months ended September 30, 2018.

~~Research and development expense~~

R&D expense was $6,430,738 in the nine months ended September 30, 2019, a decrease of $4,877,246, or 43.1%, from $11,307,984 in the nine months ended September 30, 2018. This decrease was primarily the result of a decrease in costs relating to our MRTP application with the FDA for our VLNC cigarettes of approximately $5,562,000, a decrease in equity-based compensation expense of approximately $1,477,000, partially offset by an increase in sponsored research costs of approximately $1,103,000, tobacco leaf inventory write-off of approximately $882,000, and increase in payroll and related benefits of approximately $71,000, an increase in consulting fees of approximately $44,000, and a net increase in various other R&D expenses of approximately $62,000.

~~Sales, general and administrative expense~~

Sales, general and administrative expense was $9,119,090 in the nine months ended September 30, 2019, an increase of $2,771,031, or 43.7%, from $6,348,059 in the nine months ended September 30, 2018. The increase was mainly due to an increase equity-based compensation of approximately $1,164,000, severance expenses of approximately $721,000, an increase in payroll and related benefits of approximately $632,000, an increase in legal fees of approximately $197,000, an increase in business insurance costs of approximately $169,000, an increase in consulting services of approximately $86,000, an increase in Board of Director related expenses of approximately $73,000, an increase in public company compliance costs of approximately $50,000, and a net increase in various other sales, general and administrative expenses of approximately $36,000, partially offset by a decrease in expenses relating to investor relations of approximately $357,000.

~~Impairment~~

The non-cash impairment charge for the nine months ended September 30, 2019 amounted to $1,142,349 related to the portion of our intellectual property portfolio relating to increased nicotine in tobacco; potentially reduced exposure products involving higher nicotine products; older scientific methods of working with genes in tobacco plants; methods of utilizing the biomass of tobacco plants; and trademarks that do not fit within the types of products that we desire to commercialize in the future. We incurred no impairment for the nine months ended September 30, 2018.

~~Depreciation expense~~

Depreciation expense for the nine months ended September 30, 2019 amounted to $439,955, an increase of $51,287, or 13.2%, from $388,668 for the nine months ended September 30, 2018. The increase was primarily due to an increase in depreciable assets as a result of acquisitions of machinery and equipment during the year ended December 31, 2018 and the nine months ended September 30, 2019 in the aggregate amount of approximately $967,000, primarily consisting of equipment additions in our NASCO factory operations in North Carolina.

~~Amortization expense~~

Amortization expense for the nine months ended September 30, 2019 amounted to $671,105, an increase of $113,457, or 20.3%, from $557,648 for the nine months ended September 30, 2018. The amortization expense relates to amortization taken on capitalized patent costs and license fees. The increase was primarily due to amortization taken on additional patent costs incurred during the nine months ended September 30, 2019 and the year ended December 31, 2018 of approximately $598,000 and $809,000, respectively, and additional amortization of approximately $70,000 taken during the first nine months of 2019 on the cost of a new licenses with NCSU and the University of Kentucky that began in the third and fourth quarters of 2018.

~~Unrealized (loss) gain on investment~~

The warrants to purchase 973,971 shares of Aurora common stock, described in Note 4 to our consolidated financial statements, are considered an equity security, and are recorded at fair value. We recorded the fair value of the stock warrants of $1,682,048 at September 30, 2019, using the Black-Scholes pricing model, and recorded an unrealized loss on the warrants in the amount of $1,410,310 for the nine months ended September 30, 2019. The unrealized loss was primarily due to a decrease in the underlying stock price of Aurora’s common stock.

The Company recorded the fair value of these stock warrants of $6,731,114 at September 30, 2018, using the Black-Scholes pricing model, and recorded an unrealized gain on the warrants in the amount of $3,923,156 for the nine months ended September 30, 2018.

In addition, during the first quarter of 2018, we began accounting for our equity investment in Anandia in accordance with Financial Accounting Standards Board ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. This guidance changed how entities account for equity investments that do not result in consolidation and are not accounted for under the equity method of accounting. Under ASU 2016-01, we are required to measure our investment in Anandia at fair value at the end of each reporting period and recognize changes in fair value in net income. A practical expedient is available for equity investments that do not have readily determinable fair values; however, the exception requires us to adjust the carrying amount for impairment and observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Accordingly, and as a result of an equity issuance by Anandia during December of 2017 and January of 2018 (orderly transactions), we recorded an unrealized gain on our investment in Anandia in the amount of $6,147,088 for the three months ended March 31, 2018.

~~The aggregate unrealized gain for the two transactions discussed above amounted to $10,070,244 for the nine months ended September 30, 2018.~~

~~Realized gain on investments~~

~~There was no realized gain on investments during the nine months ended September 30, 2019.~~

We held a 14.8% equity investment in Anandia. On August 8, 2018, all of Anandia’s outstanding common stock was acquired by Aurora in exchange for (i) free trading shares of Aurora common stock, and (ii) warrants with a five-year term to purchase one half of a share of Aurora common stock for each whole share of Aurora common stock received as part of the transaction. As a result of the transaction, we received 1,947,943 shares of Aurora common stock and warrants to purchase 973,971 shares of Aurora common stock that had a fair value at closing of $9,221,594 and $2,807,958, respectively. The Company recorded a realized gain on the transaction in the amount of $4,515,971 during the three months ended September 30, 2018. Subsequent to the transaction, we sold all our Aurora common stock resulting in net sales proceeds $13,051,503 and realized a gain on the sale of $3,829,909. The aggregate realized gains from the Anandia transaction and the sale of the Aurora shares amount to $8,345,880 for the nine months ended September 30, 2018.

~~Realized gain (loss) on short-term investment securities~~

We maintain a short-term investment account to invest our excess cash. Investments in the short-term investment account are managed in accordance with our investment policy. We realized a gain (loss) on short-term investment securities of $146,382 and ($48,461) for the nine months ended September 30, 2019 and 2018, respectively, resulting from the maturity of various debt instruments held in the short-term investment account.

~~Litigation expense~~

We accrued an expense relating to the settlement agreement in the Crede litigation in the amount of $1,890,900 for the nine months ended September 30, 2019. We had no litigation expenses for the nine months ended September 30, 2018.

~~Gain on the sale of machinery and equipment~~

During the nine months ended September 30, 2019, we sold a piece of machinery and equipment no longer required in our factory operations in North Carolina and recorded a gain on the sale in the amount of $87,351.

~~Warrant liability gain, net~~

During July of 2018, the remaining stock warrants containing the anti-dilutive features that created the warrant liability were exercised on a cashless basis. Accordingly, there was no warrant liability gain (loss) for the nine months ended September 30, 2019 and there will be no warrant liability gain (loss) in future periods unless we issue securities containing anti-dilution features.

~~The warrant liability gain of $48,711 for the first nine months of 2018 was due to a decrease in the estimated fair value of the warrants during the period.~~

~~Interest income, net~~

~~Interest income, net for the nine months ended September 30, 2019 was $757,429, a decrease of $1,236, or 0.2%, from interest income of $758,665 for the nine months ended September 30, 2018.~~

~~Interest expense~~

Interest expense was $36,550 for the nine months ended September 30, 2019 and was derived from the accretion of interest on notes payable to NCSU and the University of Kentucky, interest accretion on accrued severance and interest expense incurred relating to the financing of certain business insurance premiums. The interest expense for the nine months ended September 30, 2018 was $4,431 and was derived from interest accreted on a note payable to NCSU.

~~Net (loss) income~~

We had a net loss for the nine months ended September 30, 2019 of $20,360,113 as compared to net income of $952,490 in the nine months ended September 30, 2018. The negative change from net income to a net loss in the amount of $21,312,603 was primarily the result of the a decrease in the one-time realized gain on investments relating to the Anandia/Aurora transactions during the third quarter of 2018 of approximately $8,346,000, a negative change in the unrealized (loss) gain on investment of approximately $11,481,000, a one-time litigation expense of approximately $1,891,000, and an increase in the negative change in the gross (loss) profit on sales of product of approximately $595,000, partially offset by a decrease in operating expenses of approximately $799,000, and an increase in net other income (expense) items of approximately $201,000.

~~Other comprehensive income – unrealized gain (loss) on short-term investment securities~~

We maintain an account for short-term investment securities that are classified as available-for-sale securities and consist of money market funds, corporate bonds, U.S. government agency bonds, and U.S. treasury securities with maturities greater than three months at the time of acquisition. Unrealized gains and losses on short-term investment securities (the adjustment to fair value) are recorded as Other comprehensive income or loss. We recorded an unrealized gain on short-term investment securities in the amount of $239,341 and recorded a reclassification of gains to net loss in the amount of ~~$146,382,~~$72, resulting in other comprehensive income inof $17. For the ~~amount of $92,959 for the nine~~six months ended ~~September~~June 30, ~~2019. For the nine months ended September 30, 2018,~~2020, we recorded an unrealized ~~loss~~gain on short-term investment securities ~~in the amount~~ of ~~$36,987~~$45 and ~~recorded~~ a reclassification of losses to net ~~income in the amount~~loss of ~~$48,461,~~$0, resulting in other comprehensive income of $45. For the six months ended June 30, 2019, we recorded an unrealized gain on short-term investment securities of $236 and a reclassification of gains to net loss of $56, resulting in ~~the amount~~other comprehensive income of ~~$11,474.~~$180.

Liquidity and Capital Resources

Quarter-to-Date

Year-to-Date

June 30

June 30

June 30

June 30


2020

2019

2020

2019
Net cash used in operating activities

$
(6,811)

$
(4,063)

$
(11,473)

$
(8,744)
Net cash provided by investing activities

5,283

4,748

10,179

9,414
Net cash provided by (used) in financing activities

1,653

(400)

1,653

(400)
Net increase (decrease) in cash and cash equivalents

125

285

359

270
Cash and cash equivalents - beginning of period

719

590

485

605
Cash and cash equivalents - end of period

$
844

$
875

$
844

$
875
Short-term investment securities

$
28,103

$
46,096

$
28,103

$
46,096

Working Capital
As of ~~September~~June 30, ~~2019,~~2020, we had working capital of approximately ~~$42.7 million~~$29,974 compared to working capital of approximately ~~$56.0 million~~$36,962 at December 31, ~~2018,~~2019, a decrease of ~~approximately $13.3 million.~~$6,765. This decrease in working capital was primarily due to a decrease in net current assets of approximately ~~$13.4 million and a decrease~~$6,449 as well as an increase in net current liabilities of approximately ~~$0.1 million.~~$539. Cash, cash equivalents and short-term investment securities decreased by approximately ~~$12.6 million~~$10,015 and the remaining net current assets ~~decreased~~increased by approximately ~~$0.8 million.~~$3,566. We used approximately ~~$11.7 million~~$11,473 of cash in operating activities during the ~~nine~~six months ended ~~September~~June 30, ~~2019.~~
2020.
We must successfully execute our business ~~plan~~strategy to ~~increase revenue in order to~~ achieve profitability and positive cash flows from ~~operations~~operations. We believe that we have sufficient liquidity to ~~sustain adequate liquidity without requiring~~fund our regular business activities for the foreseeable future.
We may contemplate additional ~~funds from~~financing to fund further acquisitions, investments in technology, brand development or other opportunities. While we do not have any immediate plans to raise capital ~~raises and other external sources to meet minimum operating requirements. On December 30, 2016,~~at this time, we have filed a ~~Form~~new S-3 ~~universal~~ shelf registration ~~statement~~ with the U.S. Securities and Exchange Commission ~~(“SEC”) that was declared effective by the SEC on January 17, 2017.~~(SEC). The ~~universal~~new shelf registration ~~statement~~ will ~~allow, but not compel, the Company~~replace our previously expired shelf registration and should provide us flexibility and optionality to raise upcapital in order to ~~$100 million of capital over a three-year period ending January 17, 2020 through a wide array of securities at times and~~make crucial investments, should compelling opportunities arise in ~~amounts to be determined by~~ the Company. Following the October 2017 registered direct offering, the universal shelf registration has approximately $46 million of remaining capacity. If required, there can be no assurance that additional capital will be available on acceptable terms or at all. future.
~~Cash demands on operations~~
We had cash and cash equivalents and short-term investment securities at September 30, 2019 of $43,718,961. We believe this amount of cash and cash equivalents and short-term investment securities will be adequate to sustain normal operations and meet all current obligations as they come due for a number of years. During the nine months ended September 30, 2019, we experienced an operating loss of approximately $18,014,000 (including approximately $1,578,000 in expenses relating to our MRTP application) and used cash in operations of approximately $11,698,000. Excluding discretionary expenses relating to R&D, patent and trademark costs, contract growing of our proprietary tobacco, modified risk tobacco products and certain nonrecurring expenses relating to factory capital expenses, investor relations and marketing costs, our monthly cash expenditures are approximately $975,000. The Company will continue to incur consulting and legal expenses as the MRTP application continues through the FDA review process.
Net cash used in operating activities
~~In the nine months ended September 30, 2019, $11,697,541 of cash was used in operating activities as compared to $12,561,619~~The increase of cash used in ~~operating activities in the nine months ended September 30, 2018, a decrease of $864,078. The decrease in use of cash in~~ operations ~~was primarily due to a decrease in the cash portion of the net loss~~ in the amount of ~~$2,990,708 and~~$2,729 was due to an increase in cash used for working capital components related to operations in the amount of ~~$2,126,630~~$4,780 that was partially offset by a decrease in the cash portion of the net loss in the amount of $2,051 for the ~~nine~~six months ended ~~September~~June 30, ~~2019~~2020 as compared to the ~~nine~~six months ended ~~September~~June 30, ~~2018.~~2019. The increase in cash used for working capital components was primarily due to an increase in pre-paid D&O insurance in the amount of $2,515, of which $2,195 was financed by a note payable issuance described in the Net cash provided by (used in) financing activities section below.
40
Net cash provided by investing activities
~~In the nine months ended September 30, 2019, net~~The increase in cash provided by investing activities, ~~was $12,110,399, as compared to $9,943,795~~in the amount of ~~cash provided by investing activities during the nine months ended September 30, 2018, an increase in net cash provided by investing activities of $2,166,604. The increase~~$765, was primarily the result of an increase in net cash provided from ~~transactions relating to our~~ short-term ~~investment~~investments account in the amount of ~~$15,310,689~~$529 and ~~an increase~~a decrease in cash ~~provided~~flows related to acquisition of Patents and trademarks and Machinery and equipment of in the net amount of $402. These increased cash inflows were partially offset by a decrease in proceeds from the sale of ~~machinery~~Machinery and equipment in the amount of ~~$166,150, partially offset by a decrease proceeds received from~~$166 during the ~~sale~~first half of 2020 as compared to the ~~Aurora common stock in the third quarter~~first half of ~~2018 in the amount~~2019.

Table of ~~$13,051,503 and a net increase in cash used for the acquisition of patents and trademarks and in the acquisition of machinery and equipment in the aggregate amount of $258,732.~~Contents

Net cash ~~used in~~provided by (used in) financing activities

During the ~~nine~~six months ended ~~September~~June 30, 2020, cash provided by financing activities was $1,653 resulting from a note payable issuance of $2,195 which was offset by principal payments on our notes payable of $542. During the six months ended June 30, 2019, cash used in financing activities was ~~$400,000~~$400 resulting from a principal payment on aour note ~~payable.~~

During the nine months ended September 30, 2018, cash used in financing activities was $282,500 resulting from a principal payment on a note payable in the amount of $500,000 that was partially offset by cash provided from the exercise of stock options in the amount of $217,500.

payables.

Critical Accounting Policies and Estimates

There have been no material changes to the information set forth in our Annual Report on Form 10-K for the year ended December 31, ~~2018, except for the adoption of ASU 2016-02, Leases, on January 1, 2019 as more fully described in Note 3 to our Consolidated Financial Statements.~~

2019.

Inflation

Inflation did not have a material effect on our operating results for the ~~nine~~six months ended ~~September~~June 30, 2020 and 2019, ~~and 2018,~~ respectively.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements as defined by Item 303(a)(4) of Regulation S-K.

~~Item 3. Quantitative and Qualitative Disclosures About Market Risk~~
~~There have been no material changes to the information set forth in our Annual Report on Form 10-K for the year ended December 31, 2018.~~
41
Item 4. Controls and Procedures
(a)
Evaluation of Disclosure Controls and Procedures:
The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in its Securities Exchange Act of 1934 (“Exchange Act”) reports are recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including the Company’s ~~chief~~principal executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Our ~~chief~~principal executive officer and chief financial officer, after evaluating the effectiveness of the Company’s “disclosure controls and procedures” (as defined in the Exchange Act Rules 13a-15(e) or 15d-15(e)) as of the end of the period covered by this quarterly report, have concluded that our disclosure controls and procedures were effective as of the end of the period covered by this Form 10-Q to ensure information required to be disclosed is recorded, processed, summarized and reported within the time period specified by SEC rules, based on their evaluation of these controls and procedures as required by paragraph (b) of Exchange Act Rules 13a-15 or 15d-15.
(b)
Changes in Internal Control over Financial Reporting:
There were no changes in the Company’s internal controls over financial reporting during the ~~third~~second quarter of ~~2019~~2020 that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

42

31

Table of Contents

Part II. OTHER INFORMATION
Item 1. Legal Proceedings
~~We are subject~~See Note 11 - Commitments and Contingencies – Litigation - to ~~various~~our consolidated financial statements included in this Quarterly Report for information concerning our on-going litigation. In addition to the lawsuits described in Note 11, from time to time we may be involved in claims ~~and legal proceedings~~ arising in the ordinary course of business. ~~As of~~To our knowledge other than the ~~date hereof, we are unable~~cases described in Note 11 to ~~currently assess whether the final resolution of any of such claims or~~our consolidated financial statements, no material legal proceedings, ~~may~~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 ~~us. For a description of the current legal proceedings pending, refer to Note 9 of~~ our ~~Consolidated Financial Statements included herein.~~business and financial condition.

43
Item 1A. Risk Factors
~~Except as set forth below, there~~There have been no material changes from the risk factors disclosed in Item 1A of Part I of our Annual Report on Form 10-K for the year ended December 31, ~~2018,~~2019, as filed with the SEC on March ~~6, 2019:~~
~~The loss~~11, 2020, and Item 1A of ~~a significant customer for whom we manufacture tobacco products could have an adverse impact on our results of operation.~~
~~Currently, a significant portion~~Part II of our ~~revenues (and corresponding accounts receivable) from manufacturing tobacco products are derived from our two largest customers,~~Quarterly Report on Form 10-0Q for the three months ended March 31, 2020, as filed with whom we do not have an agreement 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 impactthe SEC on ~~our results of operations.~~May 7, 2020.

~~Federal, state and local governmental actions, including actions by the FDA, may have an adverse impact on us and/or our customers for whom we manufacture tobacco products.~~
We and our customers for whom we manufacture tobacco products face significant governmental regulation, including efforts aimed at reducing the incidence of tobacco use. Actions by the FDA and other 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), delay or prevent the launch of new or modified tobacco products or products with claims of reduced risk, 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.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None

Item 3. Default Upon Senior Securities.
None

Item 4. Mine Safety Disclosures
None

Item 5. Other Information
None

Table of Contents

Item 6. Exhibits

Exhibit 31.1
Section 302 Certification - Chief Executive Officer
Exhibit 31.2
Section 302 Certification - Chief Financial Officer
Exhibit 32.1
Certification of ~~Chief~~Principal Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.
~~101~~
101.INS
Interactive data files formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Cash Flows, and (iv) the Notes to the Consolidated Financial Statements.
~~101.INS~~
XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document

Exhibit 104
Cover Page Interactive Data File - The cover page interactive data file does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document

44

33

Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized:

22nd CENTURY GROUP, INC.
Date: ~~November 7, 2019~~August 6, 2020
/s/ ~~Clifford B. Fleet~~James A. Mish
~~Clifford B. Fleet~~
James A. Mish
~~President,~~
Chief Executive Officer ~~and Director~~
(Principal Executive Officer)
Date: ~~November 7, 2019~~August 6, 2020
/s/ John ~~T. Brodfuehrer~~Franzino
John ~~T. Brodfuehrer~~Franzino
Chief Financial Officer
(Principal Accounting and Financial Officer)

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

Title of each class		Ticker symbol		Name of Exchange on Which Registered
Common Stock, $0.00001 par value		XXII		NYSE American


Large accelerated filer	¨ ☐	Accelerated filer	x ☒

Non-accelerated filer	¨ ☐	Smaller reporting company	¨ ☒

		Emerging growth company	¨ ☐

~~Title of each class~~		~~Ticker symbol~~		~~Name of Exchange on Which~~ ~~Registered~~
~~Common Stock, $0.00001 par value~~		~~XXII~~		~~NYSE American~~

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

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