22nd Century Group, Inc. - Quarter Report: 2018 June (Form 10-Q)

Modified Risk Tobacco Product Application (“MRTP Application”) – In connection with the Company’s MRTP Application for its Brand A Very Low Nicotine Content (“VLNC”) cigarettes with the FDA, the Company has entered in various contracts with third-party service providers to fulfill various requirements of the MRTP Application. Such contracts include services for clinical trials, perception studies, legal guidance, product testing, and consulting expertise. During the three and six months ended June 30, 2018, the Company incurred expenses relating to these contracts in the approximate amount of $2,725,000 and $4,021,000, respectively. There were no expenses incurred relating to the MRTP Application for the three and six months ended June 30, 2017. Future financial commitments under these contracts are estimated to amount to approximately an additional $7,500,000 and are expected to be completed over the next six to nine months.

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

On April 26, 2016, Crede CG III, LTD. (“Crede”) filed a complaint against the Company in the United States District Court for the Southern District of New York (the “SDNY Court”) entitled Crede CG III, LTD. v. 22nd Century Group, Inc. On May 19, 2016, Crede filed an Amended Complaint that included seven counts, alleging among other things, that the Company allegedly breached and/or interfered with certain agreements entered into with Crede, including the joint venture agreement relating to efforts to sell the Company’s proprietary tobacco into China, the Tranche 1A warrant and the prior securities purchase agreement with Crede. The Amended Complaint seeks money damages, to rescind the securities purchase agreement, to obtain declaratory and injunctive relief to require the Company to issue to Crede 2,077,555 shares of the Company’s common stock under the exchange provision of the Tranche 1A warrant, and entry of an injunction prohibiting the Company from selling tobacco into China without the joint venture’s involvement. The Amended Complaint also seeks attorney’s fees and such other relief as the Court may deem just and proper. We believe that the claims are frivolous, meritless and that the Company has substantial legal and factual defenses to the claims.

On May 19, 2016, Crede filed a motion for preliminary injunction, asking the SDNY Court to require the Company to issue 2,077,555 shares of its common stock to Crede under the exchange provision of the Tranche 1A warrant. After conducting an evidentiary hearing on this motion on June 14, 2016, the SDNY Court denied Crede’s motion and held, among other things, that Crede did not prove the potential for irreparable harm or a likelihood of success on its claim for such 2,077,555 shares under the Tranche 1A warrant, and that there was a likelihood that Crede had violated the activity restrictions of the Tranche 1A warrant, which would bar Crede’s claim for such shares from the Company.

Following such ruling, on July 11, 2016, the Company filed a motion to sever the Crede lawsuit into two separate cases, requesting all claims relating to the Tranche 1A warrant and the securities purchase agreement to stay in the SDNY Court and all claims relating to the China joint venture agreement to be transferred to the United States District Court for the Western District of New York (the “WDNY Court”), where the Company’s headquarters office is located. On January 20, 2017, the SDNY Court granted the Company’s motion.

On February 14, 2017, Crede voluntarily dismissed its lawsuit against the Company in the WDNY Court.

On February 21, 2017, the SDNY Court granted the Company’s request to file a motion for summary judgment for the claims remaining in the SDNY Court, with all discovery in the case being deferred until after the SDNY Court issued its decision on the summary judgment motion of the Company.

On March 20, 2017, the Company filed its motion for summary judgment for the claims remaining in the SDNY Court. The response by Crede to the Company’s summary judgment motion was filed by Crede on May 1, 2017. On May 15, 2017, the Company filed its response to Crede’s filing.

 On December 28, 2017, the SDNY Court issued its decision in response to the Company’s motion for summary judgement, with such decision (i) granting the Company’s motion for summary judgement relating to Count II of the Amended Compliant, which eliminated Crede’s claim to rescind the prior securities purchase agreement, dated September 17, 2014, and denied Crede’s claim for the return of any money from the Company under that securities purchase agreement, and (ii) denying the Company’s motion for summary judgement on the remaining Counts of the Amended Compliant. In this decision, the SDNY Court also found that Crede breached the Activity Restrictions as defined and contained in the Tranche 1A warrant. As a result of this decision by the SDNY Court, the parties then proceeded with discovery in the case in preparation for a trial on the remaining Counts III, IV and V of the Amended Complaint, which relate to Crede’s claim (i) to exchange the Tranche 1A warrant for 2,077,555 shares of our common stock even though Crede breached the Activity Restrictions contained in the Tranche 1A warrant, (ii) for an unquantified additional amount of shares of our common stock that allegedly still remains under the Tranche 1A warrant even though Crede breached the Activity Restrictions contained in the Tranche 1A warrant; and (iii) for alleged damages for the alleged breach of the Tranche 1A warrant in an amount in excess of $18 million, plus costs and interest, even though Crede breached the Activity Restrictions contained in the Tranche 1A warrant.

On July 13, 2018, the SDNY Court denied Crede’s request to extend the discovery deadline. As a result of such ruling, the discovery in the Crede case has now been concluded. On July 20, 2018, the SDNY Court granted the request by the Company to file a motion for partial summary judgment to substantially limit the various damage claims by Crede, with the remaining schedule in the case being deferred until after the SDNY Court rules on such motion. The Company is to file its partial summary judgment motion by August 20, 2018, after which Crede is required to file its response by September 20, 2018, after which the Company will then be required to file its reply to Crede’s response by October 14, 2018.

The Company believes that the claims are frivolous, meritless and that the Company has substantial legal and factual defenses to the claims. The Company has defended and intends to continue to defend against these claims vigorously.

NOTE 11. - LOSS PER COMMON SHARE

The following table sets forth the computation of basic and diluted loss per common share for the three-month periods ended June 30, 2018 and 2017, respectively:

The following table sets forth the computation of basic and diluted loss per common share for the six-month periods ended June 30, 2018 and 2017, respectively:

Dilutive securities outstanding at June 30, 2018 and 2017, respectively, are presented below. Securities outstanding were excluded from the computation of loss per share because they would have been anti-dilutive.

NOTE 12. – EQUITY BASED COMPENSATION

On April 12, 2014, the stockholders of the Company approved the 22nd Century Group, Inc. 2014 Omnibus Incentive Plan (the “OIP”) and the authorization of 5,000,000 shares to be reserved for issuance thereunder. On April 29, 2017, the stockholders approved an amendment to the OIP to increase the number of shares available for issuance by an additional 5,000,000 shares. The OIP allows for the granting of equity and cash incentive awards to eligible individuals over the life of the OIP, including the issuance of up to an aggregate of 10,000,000 shares of the Company’s common stock pursuant to awards under the OIP. The OIP has a term of ten years and is administered by the Compensation Committee of the Company’s Board of Directors to determine the various types of incentive awards that may be granted to recipients under the OIP and the number of shares of common stock to underlie each such award under the OIP. As of June 30, 2018, the Company had available 1,802,115 shares remaining for future awards under the OIP.

During the six months ended June 30, 2018, the Company issued stock option awards from the OIP for 1,431,841 shares to eligible individuals. Stock options issued to acquire 1,131,841 shares of Company common stock have vesting periods ranging from one to three years from the date of the award, and stock options issued to acquire 300,000 shares of Company common stock were scheduled to vest upon the attainment of various milestones. During the six months ended June 30, 2017, the Company issued stock option awards from the OIP for 1,372,000 shares to eligible individuals having vesting periods ranging from one to three years from the date of the award. All stock option awards were valued using the Black-Scholes option-pricing model on the date of the award.

For the three and six months ended June 30, 2018, the Company recorded compensation expense related to stock option awards granted under the OIP of $1,682,228 and $2,246,104, respectively ($154,004 and $322,983 for the three and six months ended June 30, 2017, respectively).

As of June 30, 2018, unrecognized compensation expense related to non-vested stock options amounted to approximately $3,644,000, which is expected to be recognized as follows: $943,000, $1,113,000, $698,000 and $98,000 during 2018, 2019, 2020 and 2021, respectively. Approximately $792,000 of the unrecognized compensation expense relates to previously issued stock options, with the vesting of such stock options being based on the achievement of a certain milestones.

The Company’s Senior Vice President of Science and Regulatory Affairs, James E. Swauger, Ph.D., died on April 19, 2018. As a result, stock options to purchase a total of 900,000 shares of the Company’s common stock with an exercise price of $2.12 per share granted to Dr. Swauger on October 31, 2017 vested upon his death and are exercisable by Dr. Swauger’s beneficiaries for a period of one year from the date of his death. Additional stock options to purchase a total of 300,000 shares of the Company’s common stock with an exercise price of $2.12 per share granted to Dr. Swauger on October 31, 2017 were to vest based on the achievement of certain milestones by Dr. Swauger, and accordingly, will not vest and were cancelled. The unrecognized fair value of Dr. Swauger’s subject stock options to purchase 900,000 shares at the time of his death was $1,226,825 and was recognized as equity-based compensation during the second quarter of 2018. The unrecognized fair value of Dr. Swauger’s subject stock options to purchase 300,000 shares was $443,006.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The following assumptions were used for the six months ended June 30, 2018 and 2017:

The Company estimated the expected volatility based on data used by a peer group of public companies. The expected term was estimated using the contract life of the option. The risk-free interest rate assumption was determined using yield of the equivalent U.S. Treasury bonds over the expected term. The Company has never paid any cash dividends and does not anticipate paying any cash dividends in the foreseeable future. Therefore, the Company assumed an expected dividend yield of zero.

A summary of all stock option activity since December 31, 2016 is as follows:

The weighted average grant date fair value of options issued during the six months ended June 30, 2018 and 2017 was $1.80 and $0.97, respectively. The total fair value of options that vested during the six months ended June 30, 2018 and 2017 amounted to $2,306,867 and $684,265, respectively. There were 327,781 options exercised on a cash and cashless basis during the six months ended June 30, 2018 resulting in the issuance of 315,540 shares and proceeds of $217,500 to the Company. There were 56,991 options exercised on a cashless basis during the six months ended June 30, 2017 resulting in the issuance of 34,953 shares of the Company’s common stock.

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 continue to monetize the licensing of our technology and products; our ability to achieve profitability; our ability to manage our growth effectively; the lack of implementation of the plan by the FDA to regulate nicotine content in cigarettes; our ability to have a Modified Risk Tobacco Product approved by the FDA; our ability to obtain FDA clearance for our Modified Risk Cigarettes; 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 licenses. 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, 2017, which is 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 and smoking cessation products produced from modifying the nicotine content in tobacco plants through genetic engineering and plant breeding, and (ii) research and development of unique hemp/cannabis plants through genetic engineering and plant breeding to alter levels of cannabinoids to be used for potential new medicines and improved agricultural uses. We have an extensive intellectual property portfolio of issued patents and patent applications relating to the 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 U.S. Food and Drug Administration (“FDA”) to require that all combustible cigarettes sold in the United States contain only minimally or non-addictive levels of nicotine; resubmitting our Modified Risk Tobacco Product (“MRTP”) application to the FDA to obtain a reduced exposure marketing authorization for our BRAND A Very Low Nicotine Content (“VLNC”) cigarettes to be marketed in the United States as “less addictive” and/or containing 95% less nicotine than conventional tobacco cigarettes; 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.

In tobacco, we have developed proprietary VLN^TM tobacco that grows with at least 95% less nicotine than conventional cigarette tobacco. We collectively refer to all of our various types of very low nicotine tobacco under the Company’s trademark name: VLN^TM tobacco. Since 2011, we have produced more than 24 million SPECTRUM® research cigarettes containing our proprietary tobaccos for the National Institute on Drug Abuse (“NIDA”), which is part of the National Institutes of Health (“NIH”). To date, agencies of the United States federal government have invested more than $100 million in independent clinical studies using our SPECTRUM® research cigarettes. The results of these studies, as published in peer-reviewed publications, show that our proprietary VLNC cigarettes are associated with: (1) reduced smoking, (2) lower nicotine exposure, and (3) lessened nicotine dependence, all with minimal evidence of nicotine withdrawal symptoms, compensatory smoking, or serious adverse events. A list of completed and published clinical studies using cigarettes made with 22nd Century’s VLN™ tobacco is shown on the Company’s website at http://www.xxiicentury.com/published-clinical-studies/. A list of on-going clinical studies using 22nd Century’s SPECTRUM® research cigarettes is shown on the Company’s website at http://www.xxiicentury.com/on-going-clinical-studies/. The numerous independent clinical studies on VLNC cigarettes provides strong scientific support for the FDA’s announcement 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 of nicotine. 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.

In hemp, we are developing proprietary hemp strains for important new medicines and agricultural crops. Our current activities involve only work with legal hemp in full compliance with federal and state laws. The hemp plant and the cannabis/marijuana plant are both part of the same cannabis sativa genus/species of plant, except that hemp has less than 0.3% dry weight content of delta-9-tetrahydrocannabinol (“THC”) and is legal under federal and state laws. 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 federal law. We work only with legal hemp in full compliance with federal and state laws. We have developed hemp plants with zero (-0-) amounts of THC (“ZERO-THC”). We believe that our ZERO-THC hemp plants are a potential solution to one of the biggest challenges facing the legal hemp industry because, currently, hemp crops that grow with THC levels above the legal limit of 0.3% THC are required to be destroyed and hemp farmers cannot obtain crop insurance to protect against this risk. However, our ZERO-THC hemp plants can be a potential solution to this risk since our ZERO-THC hemp plants will not develop THC above the legal limits for hemp. In the United States, we are working with the University of Virginia (“UVA”) to (i) create unique industrial hemp plants with guaranteed levels of THC below 0.3% ̶ the legal limit that defines hemp for optimal growth in Virginia (thus eliminating the risk to growers of having to destroy non-conforming hemp crops), (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, (iii) utilize high-value medical cannabinoid hemp varieties and specialized cannabinoid extraction processes for use in human therapeutics, and (iv) use our unique hemp plants for phytoremediation to clean up and reclaim polluted soils. We have also obtained a license in the State of New York to research and grow hemp. In Canada, we conduct sponsored research on the hemp plant with Anandia Laboratories in Vancouver, British Columbia, in full compliance with Canadian regulations.

Additional information about our business and operations is contained in our Annual Report on Form 10-K for the year ended December 31, 2017.

Strategic Objectives

Our strategic objectives include the following:

 For the second quarter of 2018, our accomplishments and notable events include:

On April 23, 2018, we announced that the Food and Drug Law Institute (“FDLI”) published an article by Dr. James Swauger, who was then the Senior Vice President of Science and Regulatory Affairs at 22nd Century. In that public policy analysis, Dr. Swauger pointed out that since it is universally accepted that nicotine is the primary addictive component of cigarettes, the tobacco industry and public health officials should logically support the nicotine reduction plan proposed by the FDA. Dr. Swauger described VLNC cigarettes as “well-studied by a diverse group of scientists” and linked these results to the FDA’s planned mandate to require that all combustible cigarettes sold in the United States contain only minimally or non-addictive levels of nicotine. In establishing the importance of the FDA’s mandate, Dr. Swauger cited an editorial in the October 2015 edition of The New England Journal of Medicine in which Drs. Michael Fiore and Timothy Baker wrote: “Reducing the nicotine content of combustible tobacco to levels that will not sustain dependence seems to us to be the most promising regulatory policy option for preventing [at least] 20 million premature deaths.” Sadly, shortly before publication of his article in FDLI, Dr. Swauger passed away unexpectedly on April 19, 2018.

On April 25, 2018, we announced that we are committed to working collaboratively with the FDA on the FDA’s planned new rule to require that all cigarettes sold in the United States contain only minimally or non-addictive levels of nicotine. In contrast, earlier that same month, Altria Group, Inc., and Reynolds American Inc. (a subsidiary of British American Tobacco) petitioned the FDA for a 90-day extension beyond the original public comment period for the FDA’s Advance Notice of Proposed Rulemaking (“ANPRM”) that was then set to end on June 14, 2018. The FDA subsequently extended the public comment period for the ANPRM, but by only an additional 30 days, to July 16, 2018.

The FDA’s ANPRM is an important step in the FDA’s official rule-making process. The ANPRM describes the independent science that supports the FDA’s proposed nicotine reduction mandate. Although the ANPRM indicates that the FDA desires to receive input on a maximum allowable nicotine level, the ANPRM already references previously completed research that found: “an absolute limit of 0.4 to 0.5 mg of nicotine per cigarette should be adequate to prevent or limit the development of addiction in most young people. At the same time, it may provide enough nicotine for taste and sensory stimulation.” The ANPRM also cites the results of independent clinical studies, including the clinical trial by Dr. Eric Donny, et al., that was published in the October 2015 issue of The New England Journal of Medicine, that found: “Those participants using cigarettes with the lowest nicotine content (0.4 mg per gram nicotine/gram of tobacco filler), demonstrated reduced dependence… with minimal evidence of withdrawal-related discomfort or safety concerns.” 22nd Century provided all of the proprietary VLNC cigarettes that made this study possible. We submitted our response to the FDA’s ANPRM on July 16, 2018. See the more detailed disclosure regarding our response to the FDA’s ANPRM in the section below.

On May 24, 2018, we announced that 41 public health and medical organizations, including the American Heart Association, the American Cancer Association, the American Medical Association and dozens of other public health and medical organizations, wrote an open letter to FDA Commissioner Dr. Scott Gottlieb urging the FDA to quickly implement its plan to reduce nicotine in cigarettes to minimally or non-addictive levels. In their letter, these well-known public health and medical organizations described the “massive public health benefits” that will result from the adoption of the FDA’s plan to reduce nicotine in cigarettes as follows: “Every day that passes means more kids moving from experimentation to addiction and more adults who want to quit and try to quit, but remain addicted to a lethal product. We urge FDA to issue a proposed rule within six months of its ANPRM (by September 16, 2018) and a final rule six months later (by March 16, 2019). We also urge that implementation of the rule be no later than the one-year period provided for in Section 907 of the Family Smoking Prevention and Tobacco Control Act, which would allow the rule to be implemented by March of 2020.”

On June 20, 2018, we announced that our Company had initiated three short-term studies investigating the behavioral and biochemical responses to our Company’s proprietary VLN^TM tobacco. We will submit the data collected from these studies as part of our revised and enhanced MRTP application to the FDA for “BRAND A” VLNC cigarettes.

On June 25, 2018, we announced that our Company was added to the Russell 2000, Russell 3000, and Russell Global Indexes when FTSE Russell (“Russell”) reconstituted its U.S. and global equity indexes on June 22, 2018. The Russell indexes are widely used by investment managers and institutional investors for index funds and as benchmarks for investment strategies. In that same announcement, we also stated that our Company’s research partner, Anandia Laboratories in Canada, had agreed to be acquired by Aurora Cannabis Inc. (TSX: ACB.TO). In consideration for units consisting of one share of Aurora common stock plus a warrant to purchase one-half of a share of Aurora common stock, for each share of Aurora that is issued to Anandia. The number and value of the shares of Aurora common stock and warrants that will be issued to 22nd Century in consideration for our Company’s approximately 14.8% equity ownership of Anandia will not be known until the closing of the transaction, which is currently scheduled to occur in August 2018. There is no guarantee that the transaction will be consummated.

On June 26, 2018, we announced that our Company had exclusively licensed from North Carolina State University (“NCSU”) several flue-cured and burley tobacco plant lines that grow with very low levels of nicotine. These new plants contain no foreign genetic material (non-GMO) and will compliment 22nd Century’s existing VLN^TM plants and technologies. The new, non-GMO, VLN^TM tobacco plant lines are immediately commercially viable as they are the result of multiple generations of plantings that have yielded stable, true-breeding crop lines of flue-cured and burley tobacco plants. The addition of these non-GMO tobacco varieties represents a significant advancement for 22nd Century’s next generation tobacco technology. Our new VLN^TM plant varieties will provide options for 22nd Century and for potential licensees to more readily comply with the FDA’s plan to dramatically reduce the nicotine in all combustible cigarettes sold in the United States. The non-GMO nature of these tobacco varieties will also facilitate the sale of 22nd Century’s proprietary VLN™ tobacco in some foreign countries where the use of genetically modified crops is restricted.

Subsequent to the close of the second quarter of 2018, we also announced:

On July 17, 2018, we announced that our Company submitted our public comments to the FDA’s ANPRM to develop a rule that will require that all cigarettes sold in the United States contain only minimally or non-addictive levels of nicotine. 22nd Century’s public comments to the FDA’s ANPRM describe how the FDA’s proposed rule is (i) supported by rigorous independent science, (ii) exceedingly practical and urgently needed in the interests of public health and (iii) immediately feasible. We cited the facts that our Company has produced and delivered tens of millions of our proprietary VLNC SPECTRUM® research cigarettes since the year 2011 for use in numerous completed and on-going independent clinical studies funded by agencies of the United States federal government. The results of these independent clinical studies show that upon switching to 22nd Century’s VLNC cigarettes, smokers: (1) reduce their cigarette consumption, (2) experience lessened withdrawal symptoms, and (3) increase their attempts to quit smoking. These peer-reviewed and published studies provide a solid scientific foundation for the FDA’s proposed nicotine reduction mandate. VLNC cigarettes are so promising that independent researchers estimate that in the first year after implementation of the FDA’s rule to limit cigarettes to minimally or non-addictive levels of nicotine, approximately 5 million people would stop smoking and, in as few as five years after implementation of the FDA’s plan, more than 13 million people would stop smoking.

To make VLNC cigarettes a prompt reality for all smokers, our ANPRM response announced that we are willing to license the use of our VLN™ technology and our VLN™ tobacco seeds/plants to all interested companies. The availability of this licensing opportunity negates any argument by other tobacco companies that contend it is somehow not possible to comply with the planned FDA nicotine reduction mandate.

Three Months Ended June 30, 2018 Compared to Three Months Ended June 30, 2017

Revenue - Sale of products, net

In the three months ended June 30, 2018, we realized net sales revenue from the sale of products in the amount of $6,914,913, an increase of $3,017,707, or 77.4%, from net sales revenue of $3,897,206 for the three months ended June 30, 2017. The increase in net sales revenue for the second quarter of 2018 was primarily the result of continued additional net sales revenue generated from a new contract to manufacture an existing brand of filtered cigars as compared to net sales revenue for the second quarter of 2017. Production under the new manufacturing contract began in mid-May of 2017. 

Cost of goods sold - Products

During the three months ended June 30, 2018, cost of goods sold were $6,753,199, or 97.7%, of net sales revenue. While our factory was still not at production capacity during the second quarter of 2018, we continued to make progress towards utilizing more capacity as a result of the new filtered cigar manufacturing agreement that commenced in mid-May of 2017. As a result of the increased capacity utilization, net sales revenues exceeded the cost of goods sold, which included the cost of raw material components, excise taxes and certain regulatory fees, direct manufacturing costs and an overhead allocation.

During the three months ended June 30, 2017, cost of goods sold were $4,062,261, or 104.2%, of net sales revenue. We were not yet operating our factory at full production capacity during the second quarter of 2017, but we began utilizing a portion of the excess capacity as a result of the new filtered cigar contract manufacturing agreement that commenced in mid-May of 2017. As a result, the cost of goods sold relating to product sales, which included the cost of raw material components, excise taxes and certain regulatory fees, direct manufacturing costs and an overhead allocation, exceeded net sales revenue. We also recorded an increase in our inventory reserve by $95,000 during the second quarter of 2017 that resulted in an increase in the cost of goods sold by the same amount.

Research and development expense

Research and development (“R&D”) expense was $4,781,407 in the three months ended June 30, 2018, an increase of $3,968,120, or 487.9%, from $813,287 in the three months ended June 30, 2017. This increase was primarily the result of an increase in expenses relating to our MRTP application with the FDA for our VLNC cigarettes of approximately $2,578,000, an increase in equity-based compensation of approximately $1,326,000, an increase in payroll and related benefits of approximately $92,000, an increase in costs related to our laboratory operations of approximately $117,000, an increase in consulting fees of approximately $18,000, and an increase in patent maintenance costs of approximately $15,000, partially offset by a decrease in sponsored research costs of approximately $183,000.

General and administrative expense

General and administrative expense was $1,914,971 in the three months ended June 30, 2018, an increase of $109,853, or 6.1%, from $1,805,118 in the three months ended June 30, 2017. The increase was mainly due to an increase in payroll and related benefits of approximately $89,000, an increase in equity-based compensation of approximately $186,000, an increase in legal and accounting fees of approximately $184,000, an increase in business insurance, primarily relating to Directors and Officers insurance, of approximately $21,000, and a net increase in various other general and administrative expenses of approximately $50,000, partially offset by a decrease in expenses relating to investor relations of approximately $381,000, and a decrease in other professional services of approximately $40,000.

Sales and marketing expense

During the three months ended June 30, 2018, we incurred sales and marketing expenses of $203,629, a decrease of $63,962, or 23.9%, from $267,591 in the three months ended June 30, 2017. The decrease in sales and marketing expenses was primarily the result of a decrease in payroll and related benefit costs of approximately $74,000, and a decrease in travel related expenses of approximately $13,000, partially offset by an increase in equity-based compensation of approximately $16,000, and an increase in costs related to industry trade shows of approximately $11,000.

Depreciation expense

Depreciation expense for the three months ended June 30, 2018 amounted to $131,294, an increase of $42,830, or 48.4%, from $88,464 for the three months ended June 30, 2017. The increase was primarily due to depreciable acquisitions of machinery and equipment during the year ended December 31, 2017 and the six months ended June 30, 2018 in the approximate amount of $1,596,000, primarily consisting of equipment additions in our NASCO factory operations in North Carolina, equipment additions in our laboratory facility in Buffalo, New York, and leasehold improvements to our new corporate office in Williamsville, New York. These acquisitions were placed in service at various time intervals over the last eighteen (18) months. 

Amortization expense

Amortization expense for the three months ended June 30, 2018 amounted to $170,925, an increase of $27,915, or 19.5%, from $143,010 for the three months ended June 30, 2017. 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 three months ended June 30, 2018 and the year ended December 31, 2017 in the amounts of $334,230 and $582,040, respectively.

Warrant liability loss - net

There was no material change in the fair value of our stock warrants during the three months ended June 30, 2018. As such, there was no gain or loss recorded on the change in the fair value of stock warrants during the three months ended June 30, 2018. Additionally, the remaining 94,721 stock warrants containing the anti-dilutive features that created the warrant liability were exercised on a cashless basis in July of 2018.

The warrant liability loss of $77,583 for the second quarter of 2017 was due to an increase in the estimated fair value of the warrants during the period. The increase in the estimated fair value of the warrants was primarily attributable to an increase in our underlying stock price from $1.18 per share at March 31, 2017 as compared to $1.75 per share at June 30, 2017.

Realized loss and unrealized gain on short-term investment securities

In December of 2017, we funded a short-term investment account with excess capital raised from a registered direct offering in October of 2017. Investments in the short-term investment account are managed in accordance with our investment policy. The realized loss on short-term investment securities of $42,384 for the three months ended June 30, 2018, was a loss resulting from the maturity of a corporate bonds in the short-term investment account.

During the first quarter of 2018, we recorded an unrealized loss on short-term investment securities in the amount of $92,574 that should have been recorded as other comprehensive loss. Accordingly, during the second quarter of 2018, we corrected this by reversing the first quarter unrealized loss to comprehensive loss with the offsetting portion of the reversal recorded as an unrealized gain on short-term investment securities.

Interest income, net

Interest income, net for the three months ended June 30, 2018, was $251,670, an increase of $239,545 from interest income of $12,125 for the three months ended June 30, 2017. The increase in net interest income (interest income less investment fees) was the result of net interest earned in our short-term investment account that was established in December of 2017. Interest income earned during the three months ended June 30, 2017 was the result of interest income generated from excess cash invested in a money market account.

Interest expense

Interest expense was $0 and $7,641 for the three months ended June 30, 2018 and 2017, respectively. We had no interest-bearing obligations during the three months ended June 30, 2018, and accordingly, we incurred no interest expense during that time period. Interest expense for the three months ended June 30, 2017 was derived from the interest component of severance payments made on accrued severance and the accretion of interest on a note payable.

Net loss

We had a net loss for the three months ended June 30, 2018 of $6,738,652 as compared to a net loss of $3,355,624 in the three months ended June 30, 2017. The increase in the net loss of $3,383,028, or 100.8%, was primarily the result of an increase in operating expenses of approximately $4,085,000, partially offset by an increase in gross profit on product sales of approximately $327,000, and an increase in net other income of approximately $375,000. The increase in operating expenses of $4,085,000 was primarily the result of an increase in expenses relating to our MRTP application with the FDA for our VLNC cigarettes of approximately $2,578,000, and an increase in R&D equity-based compensation of approximately $1,326,000.

Other comprehensive loss – unrealized loss on short-term investment securities, net

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, U.S. treasury securities, and commercial paper 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 loss on short-term investment securities for the three months ended June 30, 2018 in the amount of $28,184.

Six Months Ended June 30, 2018 Compared to Six Months Ended June 30, 2017

Revenue - Sale of products, net

In the six months ended June 30, 2018, we realized net sales revenue from the sale of products in the amount of $13,030,952, an increase of $6,902,229, or 112.62%, from net sales revenue of $6,128,723 for the six months ended June 30, 2017. The increase in net sales revenue for the first six months of 2018 was primarily the result of continued additional net sales revenue generated from a new contract to manufacture an existing brand of filtered cigars as compared to net sales revenue for the first six months of 2017. Production under the new manufacturing contract began in mid-May of 2017. 

Cost of goods sold - Products

During the six months ended June 30, 2018, cost of goods sold were $12,797,660, or 98.2%, of net sales revenue. While our factory was still not at production capacity during the first six months of 2018, we continued to make progress towards utilizing more capacity as a result of the new filtered cigar manufacturing agreement that commenced in mid-May of 2017. As a result of the increased capacity utilization, net sales revenues exceeded the cost of goods sold, which included the cost of raw material components, excise taxes and certain regulatory fees, direct manufacturing costs and an overhead allocation.

During the six months ended June 30, 2017, cost of goods sold were $6,567,675, or 107.2% of net sales revenue. We were not yet operating our factory at full production capacity during the six months ended June 30, 2017, but we began utilizing a portion of the excess capacity as a result of the new filtered cigar contract manufacturing agreement that commenced in mid-May of 2017. As a result, the cost of goods sold relating to product sales, which included the cost of raw material components, excise taxes and certain regulatory fees, direct manufacturing costs and an overhead allocation, exceeded net sales revenue. We also recorded an increase in our inventory reserve by $95,000 during the second quarter of 2017 that resulted in an increase in the cost of goods sold by the same amount.

Research and development expense

Research and development (“R&D”) expense was $7,298,176 in the six months ended June 30, 2018, an increase of $5,934,038, or 435.0%, from $1,364,138 in the six months ended June 30, 2017. This increase was primarily the result of an increase in expenses relating to our MRTP application with the FDA for our VLNC cigarettes of approximately $3,822,000, an increase in equity-based compensation of approximately $1,533,000, an increase in sponsored research costs of approximately $79,000, an increase in payroll and related benefits of approximately $286,000, an increase in costs related to our laboratory operations of approximately $191,000, an increase in consulting fees of approximately $39,000, an increase in travel related expenses of approximately $29,000, and an increase in patent maintenance costs of approximately $20,000, partially offset by a decrease in license and royalty fees of approximately $60,000.

General and administrative expense

General and administrative expense was $3,947,363 in the six months ended June 30, 2018, an increase of $521,766, or 15.2%, from $3,425,597 in the six months ended June 30, 2017. The increase was mainly due to an increase in payroll and related benefits of approximately $266,000, an increase in equity-based compensation of approximately $365,000, an increase in annual SEC and NYSE American compliance costs of approximately $75,000, an increase in legal and accounting expenses of approximately $201,000, and a net increase in various other general and administrative expenses of approximately $85,000, partially offset by a decrease in expenses relating to investor relations of approximately $471,000.

Sales and marketing expense

During the six months ended June 30, 2018, we incurred sales and marketing expenses of $402,738, a decrease of $160,566, or 28.5%, from $563,304 in the six months ended June 30, 2017. The decrease in sales and marketing expenses was primarily the result of a decrease in payroll and related benefit costs of approximately $154,000, a decrease in advertising and promotional costs of approximately $27,000, and a decrease in travel related expenses of approximately $18,000, partially offset by an increase in equity-based compensation of approximately $25,000, and an increase in costs related to industry trade shows of approximately 16,000.

Depreciation expense

Depreciation expense for the six months ended June 30, 2018 amounted to $255,822, an increase of $79,237, or 44.9%, from $176,585 for the six months ended June 30, 2017. The increase was primarily due to depreciable acquisitions of machinery and equipment during the year ended December 31, 2017 and the six months ended June 30, 2018 in the approximate amount of $1,596,000, primarily consisting of equipment additions in our NASCO factory operations in North Carolina, equipment additions in our laboratory facility in Buffalo, New York, and leasehold improvements to our new corporate office in Williamsville, New York. These acquisitions were placed in service at various time intervals over the last eighteen (18) months. 

Amortization expense

Amortization expense for the six months ended June 30, 2018 amounted to $338,477, an increase of $54,579, or 19.2%, from $283,898 for the six months ended June 30, 2017. 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 six months ended June 30, 2018 and the year ended December 31, 2017 in the amounts of $334,230 and $582,040, respectively.

Warrant liability gain (loss) - net

The warrant liability gain of $48,711 for the six months ended June 30, 2018 was due to a decrease in the estimated fair value of the warrants during the first quarter of 2018. We did not record any gain or loss during the second quarter of 2018 as discussed above. The decrease in the estimated fair value of the warrants during the first quarter of 2018 was primarily attributable to a decrease in our underlying stock price from $2.80 per share at December 31, 2017 as compared to $2.35 per share at March 31, 2018.

The warrant liability loss of $82,927 for the six months ended June 30, 2017 was due to an increase in the estimated fair value of the warrants during the period. The increase in the estimated fair value of the warrants was primarily attributable to an increase in the Company’s underlying stock price from $1.09 per share at December 31, 2016 as compared to $1.75 per share at June 30, 2017.

Realized loss on short-term investment securities

In December of 2017, we funded a short-term investment account with excess capital raised from a registered direct offering in October of 2017. Investments in the short-term investment account are managed in accordance with our investment policy. The realized loss on short-term investment securities of $42,189 for the six months ended June 30, 2018, was a loss resulting from the maturity of a corporate bond in the short-term investment account.

Unrealized gain on investment

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 changes how entities account for equity investments that do not result in consolidation and are not accounted for under the equity method of accounting. Under ASU 2016-01, 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. There was no change in the fair value our equity investment in Anandia during the second quarter of 2018.

During the first quarter of 2017, a dilutive event occurred bringing our investment percentage in Anandia below 20%, a threshold for the use of the equity method of accounting that we had previously used to account for our investment in Anandia. Accordingly, we discontinued applying the equity method of accounting for our investment in Anandia after such dilutive event. After the dilutive event, we accounted for our investment in Anandia under the cost method of accounting until we adopted ASU 2016-01, as described above. We recorded an unrealized gain on the investment in Anandia the amount of $346,180 for the three months ended March 31, 2017. The cost method of accounting was being used for the equity investment in Anandia during the second quarter of 2017. Accordingly, no gain or loss was recorded for the six months ended June 30, 2017.

Interest income, net

Interest income, net for the six months ended June 30, 2018 was $503,510, an increase of $475,630 from interest income of $27,880 for the six months ended June 30, 2017. The increase in net interest income (interest income less investment fees) was the result of net interest earned in our short-term investment account that was established in December of 2017. Interest income earned during the six months ended June 30, 2017 was the result of interest income generated from excess cash invested in a money market account.

Interest expense

Interest expense was $0 and $15,560 for the six months ended June 30, 2018 and 2017, respectively. We had no interest-bearing obligations during the six months ended June 30, 2018, and accordingly, we incurred no interest expense during that time period. Interest expense for the six months ended June 30, 2017 was derived from the interest component of severance payments made on accrued severance and the accretion of interest on a note payable.

Net loss

We had a net loss for the six months ended June 30, 2018 of $5,352,164 as compared to a net loss of $5,976,901 in the six months ended June 30, 2017. The decrease in the net loss of $624,737, or 10.5%, was primarily the result of an increase in the gross profit on product sales of approximately $672,000, and an increase in net other income of approximately $6,382,000, partially offset by an increase in operating expenses of $6,429,000. The increase in net other income of $6,382,000 includes the unrealized gain on our investment in Anandia of approximately $6,147,000, as discussed above. The increase in operating expenses of $6,429,000 includes the increase in expenses relating to our MRTP application with the FDA for our VLNC cigarettes of approximately $3,822,000, and the increase in R&D equity-based compensation of approximately $1,533,000.

Other comprehensive loss – unrealized loss on short-term investment securities, net

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, U.S. treasury securities, and commercial paper 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 loss on short-term investment securities for the three months ended June 30, 2018 in the amount of $28,184.

Liquidity and Capital Resources

Working Capital

As of June 30, 2018, we had working capital of approximately $53.2 million compared to working capital of approximately $63.3 million at December 31, 2017, a decrease of approximately $10.1 million. This decrease in working capital is due to a decrease in current assets of approximately $8.6 million, which is primarily due to a net decrease in cash and cash equivalents and short-term investment securities of approximately $9.2 million, offset by a net increase in all other current assets of approximately $0.6 million, and an increase in net current liabilities of approximately $1.5 million. The net decrease in cash and cash equivalents and short-term investment securities is primarily the result of cash used in operating activities during the six months ended June 30, 2018.

We must successfully execute our business plan to increase revenue in order to achieve positive cash flows from operations to sustain adequate liquidity without requiring additional funds from capital raises and other external sources to meet minimum operating requirements. On December 30, 2016, we filed a Form 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. The universal shelf registration statement will allow, but not compel, the Company to raise up to $100 million of capital over a three-year period ending January 17, 2020 through a wide array of securities at times and 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.

Cash demands on operations

We had cash and cash equivalents and short-term investment securities at June 30, 2018 of $53,454,401. 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 six months ended June 30, 2018, we experienced an operating loss of approximately $12,009,000 (including approximately $4,021,000 in expenses relating to our MRTP application) and used cash in operations of approximately $8,391,000. 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 $850,000. In addition, we expect to incur an estimated amount of approximately an additional $7,500,000 in expenses relating to our MRTP application over approximately the next six to nine months.

Net cash used in operating activities

In the six months ended June 30, 2018, $8,390,785 of cash was used in operating activities as compared to $7,051,357 of cash used in operating activities in the six months ended June 30, 2017, an increase of $1,339,428. The increase in use of cash in operations was primarily due to an increase in the cash portion of the net loss in the amount of $3,344,243, offset by a decrease in the use of cash used for working capital components related to operations in the amount of $2,004,815 for the six months ended June 30, 2018 as compared to the six months ended June 30, 2017.  

Net cash provided by (used in) investing activities

In the six months ended June 30, 2018, net cash provided by investing activities was $8,387,140, as compared to $146,769 of cash used in investing activities during the six months ended June 30, 2017, an increase in net cash provided by investing activities of $8,533,909. The increase was primarily the result of an increase in net cash provided from transactions in our short-term investment account in the amount of $8,824,128, offset by 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 $290,219.

Net cash (used in) provided by financing activities

During the six months ended June 30, 2018, $282,500 of cash was used in financing activities, resulting from a $500,000 payment on a note payable, partially offset by $217,500 cash raised from the exercise of various stock options.

During the six months ended June 30, 2017, $6,212,712 of cash was provided by financing activities and was the result of net cash raised from the exercise of stock warrants.

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, 2017.

Inflation

Inflation did not have a material effect on our operating results for the six months ended June 30, 2018 and 2017, 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, 2017.

Item 4. 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 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 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.

There were no changes in the Company’s internal controls over financial reporting during the second quarter of 2018 that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

Part II. OTHER INFORMATION

Item 1. Legal Proceedings

We are subject to various claims and legal proceedings arising in the ordinary course of business. As of the date hereof, we are unable to currently assess whether the final resolution of any of such claims or legal proceedings may have a material adverse effect on us.

On April 26, 2016, Crede CG III, LTD. (“Crede”) filed a complaint against the Company in the United States District Court for the Southern District of New York (the “SDNY Court”) entitled Crede CG III, LTD. v. 22nd Century Group, Inc. On May 19, 2016, Crede filed an Amended Complaint that included seven counts, alleging among other things, that the Company allegedly breached and/or interfered with certain agreements entered into with Crede, including the joint venture agreement relating to efforts to sell the Company’s proprietary tobacco into China, the Tranche 1A warrant and the prior securities purchase agreement with Crede. The Amended Complaint seeks money damages, to rescind the securities purchase agreement, to obtain declaratory and injunctive relief to require the Company to issue to Crede 2,077,555 shares of the Company’s common stock under the exchange provision of the Tranche 1A warrant, and entry of an injunction prohibiting the Company from selling tobacco into China without the joint venture’s involvement. The Amended Complaint also seeks attorney’s fees and such other relief as the Court may deem just and proper. We believe that the claims are frivolous, meritless and that the Company has substantial legal and factual defenses to the claims.

On May 19, 2016, Crede filed a motion for preliminary injunction, asking the SDNY Court to require the Company to issue 2,077,555 shares of its common stock to Crede under the exchange provision of the Tranche 1A warrant. After conducting an evidentiary hearing on this motion on June 14, 2016, the SDNY Court denied Crede’s motion and held, among other things, that Crede did not prove the potential for irreparable harm or a likelihood of success on its claim for such 2,077,555 shares under the Tranche 1A warrant, and that there was a likelihood that Crede had violated the activity restrictions of the Tranche 1A warrant, which would bar Crede’s claim for such shares from the Company.

Following such ruling, on July 11, 2016, the Company filed a motion to sever the Crede lawsuit into two separate cases, requesting all claims relating to the Tranche 1A warrant and the securities purchase agreement to stay in the SDNY Court and all claims relating to the China joint venture agreement to be transferred to the United States District Court for the Western District of New York (the “WDNY Court”), where the Company’s headquarters office is located. On January 20, 2017, the SDNY Court granted the Company’s motion.

On February 14, 2017, Crede voluntarily dismissed its lawsuit against the Company in the WDNY Court.

On February 21, 2017, the SDNY Court granted the Company’s request to file a motion for summary judgment for the claims remaining in the SDNY Court, with all discovery in the case being deferred until after the SDNY Court issued its decision on the summary judgment motion of the Company.

On March 20, 2017, the Company filed its motion for summary judgment for the claims remaining in the SDNY Court. The response by Crede to the Company’s summary judgment motion was filed by Crede on May 1, 2017. On May 15, 2017, the Company filed its response to Crede’s filing.

 On December 28, 2017, the SDNY Court issued its decision in response to the Company’s motion for summary judgement, with such decision (i) granting the Company’s motion for summary judgement relating to Count II of the Amended Compliant, which eliminated Crede’s claim to rescind the prior securities purchase agreement, dated September 17, 2014, and denied Crede’s claim for the return of any money from the Company under that securities purchase agreement, and (ii) denying the Company’s motion for summary judgement on the remaining Counts of the Amended Compliant. In this decision, the SDNY Court also found that Crede breached the Activity Restrictions as defined and contained in the Tranche 1A warrant. As a result of this decision by the SDNY Court, the parties then proceeded with discovery in the case in preparation for a trial on the remaining Counts III, IV and V of the Amended Complaint, which relate to Crede’s claim (i) to exchange the Tranche 1A warrant for 2,077,555 shares of our common stock even though Crede breached the Activity Restrictions contained in the Tranche 1A warrant, (ii) for an unquantified additional amount of shares of our common stock that allegedly still remains under the Tranche 1A warrant even though Crede breached the Activity Restrictions contained in the Tranche 1A warrant; and (iii) for alleged damages for the alleged breach of the Tranche 1A warrant in an amount in excess of $18 million, plus costs and interest, even though Crede breached the Activity Restrictions contained in the Tranche 1A warrant.

On July 13, 2018, the SDNY Court denied Crede’s request to extend the discovery deadline. As a result of such ruling, the discovery in the Crede case has now been concluded. On July 20, 2018, the SDNY Court granted the request by the Company to file a motion for partial summary judgment to substantially limit the various damage claims by Crede, with the remaining schedule in the case being deferred until after the SDNY Court rules on such motion. The Company is to file its partial summary judgment motion by August 20, 2018, after which Crede is required to file its response by September 20, 2018, after which the Company will then be required to file its reply to Crede’s response by October 14, 2018.

The Company believes that the claims are frivolous, meritless and that the Company has substantial legal and factual defenses to the claims. The Company has defended and intends to continue to defend against these claims vigorously.

Item 1A. Risk Factors

Our risk factors have not changed materially from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2017, as filed with the SEC on March 7, 2018.

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

On July 6, 2018, we issued 63,832 shares of common stock to an investor from the cashless exercise of 94,721 warrants to purchase shares of our common stock. 

The shares were offered and sold pursuant to exemptions from the registration requirements under Section 4(2) of the Securities Act of 1933, as amended, and Rule 506 of Regulation D promulgated thereunder.

Item 3. Default Upon Senior Securities.

None

Item 4. Mine Safety Disclosures

None

Item 5. Other Information

None

Item 6. Exhibits

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: