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Item 7. Management’s Discussion and Analysis

2021-03-11 compared with 2020-03-11 · 284 added, 523 removed, 21 unchanged (97% of the section changed)

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

This discussion should be read in

conjunction with the other sections of this Form 10-K, including “Risk Factors,” and the Financial Statements and

notes thereto.

This section of the Form 10-K generally discusses 2019 and 2018 items and year-to-year comparisons of 2019

Discussions of 2017 items and year-to-year comparisons of 2018 and 2017 that are not included in this Form 10-K can

be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations”

II, Item 7 on our Annual Report on Form 10-K for the year ended December 31, 2018.

The various sections of this

discussion contain a number of forward-looking statements, all of which are based on our current expectations and could be

affected by the uncertainties and risk factors described throughout this Annual Report on Form 10-K.

“Forward-Looking Statements.” Our actual results may differ materially.

For purposes of this Management’s

Discussion and Analysis of Financial Condition and Results of Operations, references to the “Company,”

“we,” us” or “our” refer to the operations of 22nd Century Group, Inc.

and its direct and

indirect subsidiaries for the periods described herein.

Business Overview

We are a plant biotechnology company focused on (i) developing reduced risk tobacco cigarettes produced from modifying the

nicotine content in tobacco plants through genetic engineering and modern plant breeding, and (ii) research and development

of unique hemp/cannabis plants through genetic engineering and modern plant breeding to alter levels of cannabinoids to be

used for potential new medicines and to improve other agronomic traits for improved agricultural applications.

in tobacco is to reduce the harm caused by smoking by introducing adult smokers to our proprietary, Very Low Nicotine Content

(“VLNC”) tobacco and cigarettes.

Our mission in hemp/cannabis is to develop proprietary varieties of hemp with

valuable cannabinoid profiles and other superior agronomic traits.

We have a significant intellectual property portfolio of

issued patents and patent applications relating to the tobacco and hemp/cannabis plants.

We currently are primarily involved in the

following activities:

Continuing to work with the FDA on our Modified Risk Tobacco Product application

(“MRTPA”) that we have submitted to the FDA to obtain a reduced exposure marketing authorization for our

Very Low Nicotine Content (“VLNC”) cigarettes to be marketed in the United States under the proposed brand

name of VLN ®

as containing 95% less nicotine than conventional tobacco cigarettes, and other related claims

as may be approved by the FDA;

Facilitating the 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;

Seeking licensing agreements and strategic partnerships to commercialize our VLNC tobacco technology and/or our VLNC proprietary tobaccos in the U.S.

and internationally;

Continuing to produce SPECTRUM ®

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 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;

Continuing to explore opportunities to create shareholder value

through partnerships, investments and other strategic relationships across the entire hemp/cannabis value chain, including branded

consumer products;

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

Recent Developments

For the fourth quarter of 2019, our accomplishments and notable

events include:

On November 25, 2019, we entered into Warrant

Exercise Agreements (the “Exercise Agreements”) with all of the holders (the “Exercising Holders”) of our

outstanding warrants to purchase up to 11,293,211 shares of common stock with an exercise price of $2.15 per share (the "Original

Warrants") whereby we and the Exercising Holders agreed that the Exercising Holders would exercise for cash all of the Original

Warrants at a reduced exercise price of $1.00 per share, generating gross proceeds of approximately $11.3 million.

In consideration

for the Exercising Holders exercising their Original Warrants for cash, we issued to each Exercising Holder a new warrant (each,

a "New Warrant") to purchase shares of common stock equal to the number of shares of common stock underlying the Original

The terms of the New Warrants are substantially similar to the terms of the Original Warrants, except that the New Warrants

are (i) exercisable from first issuance of the New Warrants for a period of five years and (ii) have an exercise price equal to

$1.11 per share.

On December 3, 2019, we announced that

we had conducted an initial closing of an investment in Panacea, a vertically-integrated developer, producer and seller of

legal, hemp-derived, CBD products, with extraction, distillation, testing and manufacturing operations located in a 51,000

square foot facility in Golden, Colorado.

In that public announcement, we stated that our investments in Panacea from such

initial closing through the ensuing twelve to eighteen month period are expected to be approximately $24 million, in a

combination of cash and shares of our common stock in exchange for Panacea-issued debt and Panacea preferred stock.

received a warrant from Panacea to purchase additional shares of preferred stock of Panacea, which upon full exercise will

provide us with a controlling equity position in Panacea.

To date, the Company has issued a $7 million convertible note

receivable, purchased 3,733,334 shares of Series B Preferred Shares at a cost of $5 million, issued 1,297,017 shares of 22nd

Century common stock to Panacea, and received a warrant to purchase additional Series B Preferred Shares at $2.344.

On December 17, 2019, the FDA publicly

announced that the FDA had authorized us to market in the U.S.

our VLNC tobacco cigarettes under the product names of Moonlight ®

and Moonlight Menthol ®

that were the subject of our Premarket Tobacco product application (“PMTA”).

Our Moonlight ®

and Moonlight Menthol ®

cigarettes are made with our proprietary VLNC tobacco and,

as a result, contain very low levels of nicotine.

Our Moonlight ®

and Moonlight Menthol ®

were modeled after our VLNC SPECTRUM ®

research cigarettes.

Our PMTA references more than 50 independent studies

conducted using our proprietary SPECTRUM ®

research cigarettes.

In its public announcement relating to our PMTA,

the FDA stated that following a rigorous science-based review of our PMTA, the FDA had determined that authorizing these reduced

nicotine products for sale in the U.S.

is appropriate for the protection of the public health because of, among several key considerations,

the potential to reduce nicotine dependence in addicted adult smokers, who may also benefit from decreasing nicotine exposure

and cigarette consumption.

The FDA further stated that the FDA had determined that non-smokers, including youth, are also unlikely

to start using these products, and those who experiment are less likely to become addicted than people who experiment with conventional

On February 14, 2020, the FDA’s

Tobacco Products Scientific Advisory Committee (“TPSAC”) conducted a public hearing regarding our MRTPA for our

VLNC tobacco cigarettes for which we are requesting a reduced exposure marketing authorization from the FDA to market our

VLNC tobacco cigarettes in the U.S.

as a Modified Risk Tobacco Product with product labeling that includes the proposed brand

name of VLN ®

and states that the VLN ®

product has 95% less nicotine than conventional

Our MRTPA requests FDA authorization for us to state on packaging and advertising that, among other things, the

proposed VLN ®

cigarettes contain “95% Less Nicotine.”

In contrast, an analysis of the top 100

leading cigarette styles in the United States showed that conventional and highly addictive cigarettes currently sold in the

United States contain an average of 19.4mg of nicotine per gram of tobacco (with an actual nicotine range of 14.7mg to 33.2mg

per gram of tobacco).

The MRTPA states that 22nd Century’s proposed VLN ®

cigarettes are the same as the

lowest nicotine content style of the Company’s SPECTRUM ®

research cigarettes.

Our SPECTRUM ®

cigarettes were developed in collaboration with the FDA and other U.S.

federal government agencies to provide independent

scientists with the products necessary to investigate the public health benefits of reduced-nicotine content cigarettes.

MRTPA references more than 50 independent studies that utilized SPECTRUM ®

research cigarettes.

This meeting was the first time that TPSAC

considered an MRTP application for a modified exposure claim and also TPSAC’s first discussion of an application for a combustible

tobacco product.

We presented data in support of its product applications and FDA also presented perspectives on the applications

and posed questions for the committee members to discuss.

Recordings of the proceedings meeting materials, including briefing

materials for the committee provided by us and the FDA, and presentation given by the different stakeholders are publicly available

for review via FDA’s website.

The public comment period on the applications remains open at this time.

FDA continues to

comprehensive evaluation of our applications.

This discussion should be read in conjunction with the other sections of this Form 10-K, including “Risk Factors,” and the Financial Statements and notes thereto.

This section of the Form 10-K generally discusses 2020 and 2019 items and year-to-year comparisons of 2020 to 2019.

Discussions of 2018 items and year-to-year comparisons of 2019 and 2018 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 on our Annual Report on Form 10-K for the year ended December 31, 2019.

The various sections of this discussion contain a number of forward-looking statements, all of which are based on our current expectations and could be affected by the uncertainties and risk factors described throughout this Annual Report on Form 10-K.

See “Cautionary Note Regarding Forward-Looking Statements and Risk Factor Summary.” Our actual results may differ materially.

For purposes of this Management’s Discussion and Analysis of Financial Condition and Results of Operations, references to the “Company,” “we,” us” or “our” refer to the operations of 22nd Century Group, Inc.

and its direct and indirect subsidiaries for the periods described herein.

Executive Overview of Full Year 2020 Results

Key Business and Financial Highlights

● Securing MRTP authorization for VLN ® remains our number one priority and we are confident that the FDA is in the final stages of the review process related to our application.

We are working to ensure that the launch of VLN ® King and VLN ® Menthol King cigarettes occurs within 90 days of receiving MRTP designation.

● Since reporting third quarter 2020 earnings, we have refocused our hemp/cannabis strategy to target the upstream segment of the cannabinoid value chain:

a shift away from the already saturated U.S.

consumer market of cannabidiol (CBD) and hemp-based products.

● We have now secured four out of the five key partnerships needed to maximize each component in the upstream segment of the hemp/cannabis value chain.

These partnerships will enable us to accelerate the new development of valuable, commercial hemp/cannabis lines and intellectual property to market.

● Net sales revenue of $7.3 million for the fourth quarter of 2020 was consistent with the prior year period and improved by 8.8% to $28.1 million for the full year, compared to the full year of 2019.

● Gross profit for the fourth quarter of 2020 improved by $364 thousand and by $1.4 million for the full year, compared to each respective prior year period.

● Net loss improved by $207 thousand and $6.8 million for the fourth quarter of 2020 and full year, respectively.

Corporate Business Highlights

● On January 13, 2020, we appointed Roger O’Brien as a new member of our Board of Directors and appointed Nora Sullivan, an existing director of the Board, as the new Board Chair.

Since 2000, Mr.

O’Brien has served as President of O’Brien Associates, LLC, a general management consulting firm providing advisory and implementation services to companies in a variety of competitive industries, with a special focus on general management, technology commercialization, marketing, and strategy development.

Sullivan has served as a director of 22nd Century Group since May 18, 2015.

Sullivan is also currently President of Sullivan Capital Partners, LLC, a financial services company providing investment banking and consulting services to businesses seeking growth through acquisitions, strategic partnerships, and joint venture relationships.

Her experience includes the development and advancement of strategic initiatives and the implementation of best practice governance policies.

● On June 3, 2020, we appointed James A.

Mish as our Chief Executive Officer and John Franzino as our Chief Financial Officer.

Mish brings extensive global executive leadership experience in science-driven organizations with a recent focus on the development, manufacturing, and commercialization of active pharmaceutical ingredients (“API”), including cannabinoids, and related consumer products.

He has an outstanding track record of delivering profitable growth at both privately held and publicly traded companies.

Prior to joining 22nd Century Group, Mr.

Franzino served as Chief Financial Officer of the West Point Association of Graduates.

Additionally, he has extensive strategic financial leadership experience serving as Vice President of Finance and Controller at Bard College;

as Chief Financial Officer of Santa Fe Natural Tobacco Company, a subsidiary of Reynolds American, Inc.;

and as Chief Financial Officer of Labatt USA.

Franzino is a Certified Public Accountant (CPA) and holds a Master of Business Administration degree from Fairleigh Dickinson University.

● On September 17, 2020, we appointed Michael Koganov Sc.D., Ph.D., to our Board of Directors.

Koganov is recognized as a leading expert in the development of natural products using plant biotechnology and has achieved considerable accomplishments in physico-chemistry, biochemistry, bioelectrochemistry, and biotechnology.

He is credited with developing Electro-Membrane technology for the comprehensive processing of plants to produce protein concentrates and secondary metabolites.

● On January 19, 2021, we announced the dismissal with prejudice of the federal securities class action lawsuit captioned Noto.

22nd Century Group, Inc., 19-CV-1285 by a federal district court in the Western District of New York on January 14, 2021.

The case was initially filed in the Eastern District of New York, where it was captioned Bull v.

22nd Century Group, Inc.

1:19-CV-00409.

In denying the Plaintiffs’ request for an opportunity to file another amended Complaint, the Court held that “further amendment would be futile.”

● On January 28, 2021, we announced that we are moving our corporate headquarters to the up-and-coming Larkinville District in downtown Buffalo in March of 2021.

Our new Buffalo office space is in a state-of-the-art, restored manufacturing facility located at 500 Seneca Street, joining other multinational technology and professional services companies.

our new headquarters will accommodate all of our staff from our current office location in nearby Williamsville and has significant room for expansion.

● During February and March of 2021, our warrant holders exercised 9,577,612 warrants for cash in exchange for common stock.

In connection with these exercises, we received net proceeds of $10.0 million.

On March 10, 2021, our warrant holders exercised for cash the remaining 1,715,599 outstanding warrants and no outstanding warrants remain.

Tobacco Franchise Highlights and Notable Accomplishments

● We believe that our proprietary, reduced nicotine content cigarettes, VLN ® , have massive global market opportunity.

In 2018, the global tobacco market was worth $817 billion and of that, $714 billion, or approximately 90% of the global tobacco market is comprised of combustible cigarettes.

There are more than 1 billion global and 34 million U.S.

adult smokers.

More than two-thirds of adult smokers want to quit, yet less than ten percent of them are able to quit successfully.

We believe that smokers are actively seeking alternatives to addictive combustible cigarettes.

Based on our consumer perception studies, 60% of adult smokers indicate a likelihood to use VLN ® .

● Our VLN ® cigarettes contain 95% less nicotine than conventional cigarettes and are a familiar combustible product format that replicates the conventional cigarette experience, including the sensory and experiential elements of taste, scent, smell, and “hand-to-mouth” behavior.

VLN ® contains 0.5 milligrams of nicotine per gram of tobacco, an amount cited by the FDA, based on clinical studies, to be “minimally or non-addictive”.

The lack of reward from nicotine creates a dissociation between the act of smoking and nicotine which helps adult smokers reduced the harm caused by smoking.

● Since 2011, our reduced nicotine content cigarettes have been used in more than 50 independent scientific clinical studies by universities and institutions.

The studies, using our reduced nicotine content tobacco cigarettes, show that smokers who use our products:

(i) reduce their nicotine exposure and dependence, (ii) smoke fewer cigarettes per day, (iii) increase their number of smoke-free days, and (iv) double their quit attempts – all with minimal or no evidence of nicotine withdrawal or compensatory smoking.

● In December 2019, the FDA granted a PMTA authorization for our reduced nicotine content cigarettes, giving us the ability to sell the product.

In order to market our reduced nicotine content cigarettes under the brand name VLN ® , with pack and advertising claims stating that the product contains 95% less nicotine than conventional tobacco cigarettes, as well as related claims regarding nicotine exposure, we will need to secure an MRTP authorization from the FDA.

● As a part of the MRTP application process, on February 14, 2020, we presented our MRTP application for our reduced nicotine content cigarettes, VLN ® to the FDA’s Tobacco Products Scientific Advisory Committee (TPSAC) and passed one of the final regulatory milestones.

On April 17, 2020, the FDA set May 18, 2020, as the deadline for the submission of public comments on our MRTP application.

The public comment period is now closed and we believe that we are in the final stages of the review and decision making process.

● Throughout 2020, we were and remain focused on our primary mission and highest, near-term priority of securing MRTP authorization for our proprietary, reduced nicotine content tobacco cigarettes, VLN ® .

We are maintaining our dialogue with the FDA and are confident that the Agency is in the final stages of the review process related to our application.

In addition to our ongoing contact with the FDA, we have been and are working with various legal advisors, regulatory consultants, and government affairs specialists to highlight the public health importance of our MRTP application to encourage a near-term authorization of our application.

● We are prepared to launch VLN ® within 90 days of receiving MRTP authorization from the FDA and are in advanced discussions with potential partners in the independent, regional, and national retail trade.

We anticipate a phased rollout of VLN ® in select geographies and plan to position VLN ® in the premium pricing segment of the cigarette market.

On January 11, 2021, we announced that we will expand our growing program and increase planting in the 2021 crop year for VLN ® reduced nicotine content tobacco.

This new planting for VLN ® tobacco is in addition to our current VLN ® inventory, which we plan to use for initial sales of VLN ® .

● We believe that recent political changes will likely be favorable to our business prospects from a policy priority and regulatory standpoint.

Under the new administration, we believe that the FDA will refocus on implementing its ground-breaking Comprehensive Plan for Tobacco and Nicotine Regulation, in particular the agency’s plan to cap the amount of nicotine in combustible cigarettes to a “minimally or non-addictive” level.

We believe that the MRTP authorization and the launch of VLN ® will serve as a starting point for the FDA’s proposed mandate.

● Our research cigarettes, SPECTRUM ® , continue to fuel numerous independent, scientific studies to validate the enormous public health benefit identified by the FDA and others of implementing a national standard requiring all cigarettes to contain “minimally or non-addictive” levels of nicotine.

In December 2020, the FDA in coordination with the National Institute on Drug Abuse (NIDA) and others, submitted an order to us for 3.6 million variable nicotine research cigarettes.

● We believe that our next generation, non-GMO, plant research is the key to commercializing our reduced nicotine content tobacco and technology in international markets where non-GMO products are preferred, or GMO products are banned.

We continue to make progress in our non-GMO tobacco research.

In partnership with North Carolina State University, have completed successful research field trials that have validated new non-GMO methodologies for reducing nicotine in tobacco plants and have consistently achieved reductions in nicotine levels by as much as 99%.

During the fourth quarter of 2020, we announced that we were granted a new U.S.

10,669,552, entitled “Up-regulation of auxin response factor NbTF7”, related to the reduction of nicotine in the tobacco plant.

The new technology provides us with a rapid pathway to introduce very low nicotine traits into virtually any variety of tobacco, including bright, burley, and oriental tobacco varieties.

We have successfully applied our non-GMO technology to bright and burley varieties of tobacco and have developed a VLN ® 2.0 prototype cigarette.

We are also using our non-GMO technology to introduce reduced nicotine traits into oriental varieties of tobacco.

Hemp/Cannabis Franchise Highlights and Notable Accomplishments

● We continue to place an emphasis on our hemp/cannabis strategy to target the upstream segments of the cannabinoid value chain in the areas of plant biotechnology research, gene modification and engineering, modern plant breeding and development, and extraction.

We believe that we can differentiate ourselves in the hemp/cannabis industry by building upon our core strength and expertise in plant science and the ingredient value chain and through our strategic, operational partnerships, including the addition of our new partner, CannaMetrix.

We continue to shift our focus away from the already saturated U.S.

consumer market of cannabidiol (CBD) and hemp-based products and expect to gain ingredient cultivation capabilities and extraction and purification services through a non-binding agreement with Panacea, which is expected to provide us with operational assets, including a farm and various extraction and distillation equipment.

● We developed and launched a new, cutting-edge technology platform that will enable us and our strategic partners to quickly identify and incorporate commercially valuable traits of hemp/cannabis plants to create new, stable hemp/cannabis lines.

The platform, developed in collaboration with researchers at KeyGene, incorporates a suite of proprietary molecular tools and a large library of genomic markers and gene-trait correlations.

We have already characterized millions of high-value single nucleotide polymorphisms (SNPs).

By targeting these newly identified SNPs, we have been able to locate and isolate specific sections of genetic code from genome assemblies present in our state-of-the-art hemp/cannabis bioinformatics database.

This breakthrough enables us to quickly and easily identify the genes responsible for specific traits in a plant and is a powerful tool for us and the hemp/cannabis industry.

We have already begun discussions to license this platform to strategic partners to help them improve their plant breeding techniques and optimize their hemp/cannabis lines.

● We continue to secure commercially, valuable patents and intellectual property through our internal research capabilities and external research partnerships.

We were recently granted a new U.S.

10,787,674 B2 entitled “Trichome specific promoters for the manipulation of cannabinoids and other compounds in glandular trichomes”.

This new intellectual property enables us to develop and deliver new hemp/cannabis plants that are designed to produce cannabinoids more efficiently by activating the molecular promoters, “on/off switches,” specifically and only in the plant’s trichomes where the majority of cannabinoids are produced.

The patent application describes eight promoters, which are essentially molecular on/off switches, covering all of the major steps in the cannabinoid biosynthesis pathway and is related to the control of cannabinoid and terpene production.

● We have secured an exclusive agreement with CannaMetrix, LLC for the use of their proprietary, human cell-based testing CannaMetrix EC50Array™ technology that will enable us to accelerate the commercialization of new, disruptive hemp/cannabis plant lines and intellectual property.

CannaMetrix’s proprietary CannaMetrix EC50Array™ technology serves as a high-throughput roadmap for developing new hemp/cannabis plant lines with tailor-made cannabinoid and terpenoid profiles for use in the life science, consumer product, and pharmaceutical markets.

The human cell-based assay has the ability to measure and validate the potency and efficacy of cannabinoids and/or terpenoids through defined biomarkers and receptor activity and can rapidly identify optimum plant profiles by measuring the potency and effect on the human cell system.

● We believe that we can accelerate the development of commercially, valuable hemp/cannabis lines and related intellectual property through selective partnerships and have now secured four out of the five key partnerships needed to maximize each component in the upstream segment of the cannabinoid value chain.

2021 Priorities and Areas of Focus

We remain focused on securing FDA authorization for VLN ® .

Starting within 90-days of authorization of our MRTPA by the FDA, we are prepared to launch VLN ® cigarettes in select markets.

We believe that an equally important first priority initiative is for us to support and advance the FDA’s plan to require that all cigarettes sold in the U.S.

be made “minimally or non-addictive” by limiting their nicotine content to just 0.5 milligrams of nicotine per gram of tobacco.

We continue to target the upstream segment of the cannabinoid value chain;

creating proprietary, commercially valuable new plant lines and related intellectual property with stabilized genetics to harness and optimize hemp/cannabis plant potential.

We will seek to monetize a portion of our existing hemp/cannabis IP in 2021 and will continue to bring disruptive technology forward.

We will turn attention to the development of a third, plant-based franchise after securing MRTP authorization for VLN ® .

We will leverage our plant science expertise to develop and secure valuable intellectual property and sign lucrative strategic partnerships to support the development of this franchise.

We will maintain diligent financial execution, efficient operating structure, and balance sheet strength to support our growth initiatives.

Results of Operations

Year Ended December 31, 2020 compared to Year Ended December 31, 2019.

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

Revenue - Sale of products, net

We realized net revenue from the sale

of products in the amount of $25,832,530 during the year ended December 31, 2019, as compared to net revenues of $26,426,347 during

the year ended December 31, 2018, a decrease of $593,817, or 2%.

This decrease in net revenue was primarily the result of the

sale of SPECTRUM ®

research cigarettes during the fourth quarter of 2018 in the amount of $607,000.

were no sales of SPECTRUM ®

research cigarettes during 2019.

Costs of goods sold - Products

During the year ended December 31, 2019, cost of goods sold

were $25,818,075, or 100.0% of net sales revenue, resulting in a gross profit on sales of products in the amount of $14,455.

the year ended December 31, 2018, cost of goods sold were $25,527,360, or 97%, of net sales revenue, resulting in a gross profit

on sales of products in the amount of $898,987.

The $884,532 decline in gross profit for the year ended December 31, 2019 from

the year ended December 31, 2018 consisted primarily of an increase in fees due to the FDA on filtered cigars and the absence in

2019 of sales of SPECTRUM ®

research cigarettes.

Additionally, included in the cost of goods sold during 2019

was a net write off of obsolete finished goods and raw materials inventory in the approximate amount of $54,000, resulting in a

corresponding increase in the cost of goods sold.

Sale of products, net

Dollar Change from Prior Year

The increase in sales revenue for the year ended December 31, 2020, compared to the year ended December 31, 2019, was primarily the result of an increase in sales revenue of contract manufactured cigarettes.

Filtered cigar sales revenue increased by $3 compared to the prior year, while cigarette sales revenue increased $2,275 compared to the prior year.

The increase in filtered cigar sales was primarily driven by a volume decrease offset by price increases, compared to the prior period.

The increase in cigarette sales revenue was driven by both volume and price increases compared to the prior period.

Costs of goods sold – Products / Gross profit (loss)

Cost of goods sold

Percent of Product Sales

Dollar Change from Prior Year

Gross profit (loss)

Percent of Product Sales

Dollar Change from Prior Year

For the year ended December 31, 2020, the increase in gross profit was primarily driven by increased cigarette sales volume, increased cigarette pricing, and lower labor and overhead costs per unit driven by factory efficiencies implemented during 2020.

In addition, gross margin was impacted favorably due to a CARES Act employee retention credit which reduced payroll taxes by $112.

Research and development expense

Research and development expenses were

$8,057,147 for the year ended December 31, 2019, a decrease of $6,932,599, or 46%, from $14,989,746 for the year ended December

This decrease was primarily the result of a decrease in expenses relating to our MRTPA with the FDA for our VLNC cigarettes

of approximately $8,125,000, a decrease in equity-based compensation of approximately $1,472,000 (2018 included approximately $1,230,000

in equity-based compensation recognized due to the death of our Senior Vice President of Science and Regulatory Affairs in the

second quarter of 2018), partially offset by an increase in sponsored research costs of approximately $1,310,000, an increase in

consulting fees of approximately $139,000, an increase in the net write off of our tobacco leaf inventory of approximately

$985,000, an increase in severance expense of approximately $160,000,

and approximately $125,000 in additional royalty expenses during the year ended December 31, 2019, as compared to the year ended December 31, 2018.

Sales, general and administrative expense

Research and Development

Percent of Product Sales

Dollar Change from Prior Year

Lower R&D expense in the year ended December 31, 2020, as compared to the prior year, was primarily driven by a decrease in R&D personnel expense and a decrease in tobacco leaf inventory impairment.

Personnel expense decreased by $1,285 year over year, due to more focused R&D headcount to accomplish our strategies.

Tobacco leaf inventory impairment decreased by $625 year over year.

Additionally, license and contract costs decreased $213

compared to prior year.

The lower license and contract spending is primarily a result of 2019 milestone payments for certain research agreements which were not due in the current year.

We continue to prioritize our R&D activities to achieve our strategic objectives.

Research and development expense—MRTP

Research and Development - MRTP

Percent of Product Sales

Dollar Change from Prior Year

MRTP expenses for the year ended December 31, 2020 declined significantly, as we submitted our MRTP application to the FDA during 2019.

MRTP-related expenses for 2020 are primarily related to our February 14, 2020 Tobacco Products Scientific Advisory Committee (TPSAC) hearing, offset by the finalization of a 2019 cigarette cessation study which resulted in a reimbursement of $124.

Sales, general and administrative expense

was $12,956,417 for the year ended December 31, 2019, an increase of $4,370,884, or 51%, from $8,585,533 for the year ended December

The increase was primarily due to an increase in equity-based compensation of approximately $1,825,000, an increase

in payroll and payroll related benefits of approximately $2,031,000 (including approximately $720,000 in one-time severance costs),

an increase in legal and other professional expenses of approximately $452,000, an increase in business insurance expenses of

approximately $190,000, an increase in consulting fees of approximately $100,000,an increase in repairs & maintenance expense

of approximately $80,000, an increase in Board of Director related expenses of $72,500, and an increase in travel and entertainment

expenses of approximately $70,000, partially offset by a decrease in expenses relating to investor relations of approximately

$455,000 during the year ended December 31, 2019 as compared to the year ended December 31, 2018.

The non-cash impairment charge for the year

ended December 31, 2019 amounted to $1,142,349 and 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 year ended December 31, 2018.

Sales, general and administrative

Percent of Product Sales

Dollar Change from Prior Year

The increase in sales, general and administrative (“SG&A”) expense during the year ended December 31, 2020, as compared to the prior year, was driven by a $1,613 increase in insurance expenses, a $1,227 increase in consulting and professional services expenses, a $1,385 increase in personnel expense, and a $131 increase in marketing expenses.

We have deployed this incremental SG&A spending to place new members of the management team, including our CEO, to support our efforts in governmental affairs related to the approval of our MRTP application, as well as to conduct pre-market research in anticipation of the authorization of our MRTP filing for VLN ® .

These increases in SG&A were partially offset by decreased one-time severance expenses of $415, and decreased equity compensation expense of $1,639—both driven primarily by management changes in the third quarter of 2019.

Additionally, legal fees decreased by $435 compared to the prior year.

Impairment of intangible assets

Percent of Product Sales

Dollar Change from Prior Year

During the years ended December 31, 2020 and 2019, management conducted a review of intellectual property assets and determined that impairment was required for certain patent and trademark costs.

As such, we recorded impairment charges of approximately $176 and $1,142 for the current year and prior year, respectively.

Refer to Note 5 to our consolidated financial statements for additional information.

Depreciation expense

Depreciation expense for the year ended December 31, 2019 amounted

to $589,310, an increase of $66,615, or 12.7%, from $522,695 for the year ended December 31, 2018.

The increase was primarily due

to depreciable acquisitions of machinery and equipment during the years ended December 31, 2019 and 2018 in the approximate amount

of $527,000 and $449,000, respectively, 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 corporate office in Williamsville,

Percent of Product Sales

Dollar Change from Prior Year

The increase in depreciation expense was primarily due to additional machinery and equipment acquisitions during 2020 and 2019 to for our production facility in North Carolina.

Amortization expense

Amortization expense, relating to amortization

taken on capitalized patent costs and license fees, for the year ended December 31, 2019 amounted to $835,693, an increase of

$16,053, or 2.0%, from $819,640 for the year ended December 31, 2018.

The increase is primarily due to amortization on additional

patent costs incurred during the years ended December 31, 2018, and 2019 in the amounts of $751,492 and $1,233,806.

This was partially

offset by lower amortization expense on a lower patent asset base, following Impairment charges of $1,142,349 during the third

quarter of 2019.

Percent of Product Sales

Dollar Change from Prior Year

Amortization expense relates to amortization taken on capitalized patent costs and license fees.

The decrease was primarily due to amortization expense on a lower patent base which resulted from one-time impairment charges as described in the “Impairment expense” section above.

Unrealized (loss) gain on investments

In January of 2018, Anandia closed a private

placement of common stock reducing our equity investment in Anandia to 14.8%.

On August 8, 2018, all of Anandia’s outstanding

common stock was acquired by Aurora Cannabis, Inc.

(“Aurora”) (TSX:

ACB.TO), in exchange for (i) free trading shares

of Aurora common stock, and (ii) warrants with a five-year term to purchase one-half of a share of Aurora common stock for each

whole share of Aurora common stock received as part of the transaction (the “Anandia transaction”).

As a result of

the Anandia 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 of $9,221,594 and $2,807,958, respectively.

The warrants to purchase 973,971 shares

of Aurora common stock, described above and in Note 8 to our financial statements, are considered an equity security, and are

recorded at fair value.

The Company recorded the fair value of the stock warrants of $673,010 at December 31, 2019, using the

Black-Scholes pricing model, and recorded an unrealized loss on the warrants in the amount of $2,419,348 for the year ended December

For the year ended December 31, 2018, we recorded the fair value of these warrants of $3,092,358 and recorded an unrealized

gain of $284,400.

The decrease in the fair value of the stock warrants is primarily related to the decrease in the stock price

Realized gain on investments

There were no realized gains on investments

As a result of the Anandia transaction described above, we recorded

a realized gain on the transaction in the amount of $4,515,971 during the third quarter of 2018.

Additionally, the unrealized gain

on our investment in Anandia in the amount of $6,147,088 from the first quarter of 2018 became a realized gain

at time the security was sold.

Subsequent to the Anandia 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 realized gain from the Anandia transaction, the gain

from ASU 2016-01, and the sale of the Aurora common shares resulted in an aggregate realized gain of $14,492,968 for the year ended

December 31, 2018.

Unrealized gain (loss) on investments

Percent of Product Sales

Dollar Change from Prior Year

The warrants to purchase 81,164 shares of Aurora Cannabis, Inc (“Aurora”) common stock are considered an equity security and are recorded at fair value.

We recorded the fair value of the stock warrants of $239 at December 31, 2020, using the Black-Scholes pricing model, and recorded an unrealized loss on the warrants in the amount of $434 for the year ended December 31, 2020.

Impairment of Panacea Investment

Percent of Product Sales

Dollar Change from Prior Year

During 2020, we incurred impairment charges on our investment in Panacea.

Refer to Note 6 to our consolidated financial statements for additional information regarding our investment in Panacea.

Realized gain (loss) on short-term investment securities

The realized gain on short-term investment

securities for the year ended December 31, 2019 was $220,872, an increase of $275,323 from a loss of $54,451 for the year ended

December 31, 2018.

The realized gain on short-term investment securities was the result of the maturity of various debt instruments

held in the short-term investment account.

Investments in the short-term investment account are managed in accordance with our

investment policy.

Realized gain (loss) on short-term investment securities

Percent of Product Sales

Dollar Change from Prior Year

The realized gain on short-term investment securities for the year ended December 31, 2020 was $5, a decrease of $216 from the gain of $221 realized for the year ended December 31, 2019.

The realized gain on short-term investment securities was the result of the maturity of various debt instruments held in the short-term investment account.

Investments in the short-term investment account are managed in accordance with our investment policy.

Litigation settlement expense

We incurred an expense relating to the settlement agreement

in the Crede litigation in the amount of $1,890,900 for the year ended December 31, 2019.

We had no litigation settlement expenses

for the year ended December 31, 2018.

We incurred an expense relating to the settlement agreement in the Crede litigation in the amount of $1,891 for the year ended December 31, 2019.

We had no litigation settlement expenses for the year ended December 31, 2020.

Gain on the sale of machinery and equipment

During the year ended December 31, 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.

We had no sales of machinery and equipment during the year ended 2018.

Warrant liability gain (loss), net

There were no warrants with anti-dilution

features outstanding during 2019 and, therefore, no warrant liability gain (loss) was recorded in 2019 compared to a $48,711 gain

for the year ended December 31, 2018.

Dividend income

We received no dividend income for

the year ended December 31, 2019, a decrease of $221,991 from the year ended December 31, 2018.

During the period of 2018

that we owned common stock in Aurora, Aurora spun off a subsidiary into a separate publicly traded Canadian company.

Non-Canadian shareholders received a one-time cash dividend and as a result of this transaction we received a cash dividend

in the amount of $221,991

Gain on the sale of machinery and equipment

Percent of Product Sales

Dollar Change from Prior Year

We recognized a small gain on equipment sold during the year ended December 31, 2020.

During the year ended December 31, 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.

Interest income, net

Interest income, net for the year

ended December 31, 2019 was $1,066,324, a decrease of $2,712 from interest income of $1,069,036 for the year ended December

The decrease in net interest income (interest income less investment fees) was the result of lower interest-bearing

balances largely offset with the addition of approximately $76,000 interest income earned on the convertible note receivable

from Panacea during 2019 as compared to 2018.

Interest Income, net

Percent of Product Sales

Dollar Change from Prior Year

Interest income, net (interest income less investment fees) for the year ended December 31, 2020 is comprised of cash interest on our convertible note receivable and short-term investment securities, and non-cash interest accretion on our convertible note, preferred stock investment in Panacea, and short-term investment securities purchased at a discount or premium.

During 2020, the increase in interest income, net was driven by an increase in non-cash interest income, net of $347 and an increase in cash interest income, net of $338.

Interest expense

Interest expense was $56,382 and

$10,939 for the years ended December 31, 2019 and 2018, respectively.

The interest expense for the year ended December 31,

2019 was primarily derived from interest accreted on notes payable to NCSU and the University of Kentucky, and interest

accretion on accrued severance.

We had a net loss for the year ended December 31, 2019 of $26,558,544

as compared to a net loss of $7,966,911 for the year ended December 31, 2018, an increase in the net loss of $18,591,633, or 233%.

This increase in the net loss was primarily the result of a decrease in the one-time realized gain on investments relating to the

Anandia/Aurora transactions during 2018 of approximately $14,493,000, a decrease in the unrealized gain (loss) on the Aurora stock

warrants of approximately $2,704,000, a one-time litigation settlement expense of approximately $1,891,000, and a reduction in

gross profit of approximately $885,000, partially offset by a decrease in operating expenses of approximately $1,337,000, and an

increase in net other income (expense) items of approximately $44,000.

Interest Expense

Percent of Product Sales

Dollar Change from Prior Year

Interest expense for 2020 was $16 higher than the prior year.

Interest expense for the year ended December 31, 2020 and 2019 related to interest accretion on notes payable to NCSU and the University of Kentucky, and interest accretion on accrued severance.

2020 also included cash interest expense of $29 on notes payable for D&O insurance.

Percent of Product Sales

Dollar Change from Prior Year

The decrease in net loss for the year ended December 31, 2020 compared to the prior year ended December 31, 2019, was primarily the result of improved gross profit, lower total operating expenses, one-time 2019 litigation settlement costs that did not repeat in 2020, lower unrealized loss on our Aurora warrants, and increased interest income primarily related to the Panacea investment.

These impacts were somewhat offset by 2020 impairment charges on our Panacea investment (see Note 6 to our consolidated financial statements).

Other comprehensive income

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.

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 gain on short-term investment securities in the amount of $206,583 and recorded a reclassification

of gains to net loss in the amount of $220,872 resulting in an other comprehensive loss of $14,289 for the year ended December

31, 2019, compared to an other comprehensive gain of $21,363 for the year ended December 31, 2018.

Other Comprehensive Income (Loss)

Percent of Product Sales

Dollar Change from Prior Year

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 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 $72 and a reclassification of gains to net loss of $5, resulting in other comprehensive income of $67 for the year ended December 31, 2020.

For the year ended December 31, 2019, we recorded an unrealized gain on short-term investment securities of $207 and a reclassification of gains to net loss of $221, resulting in other comprehensive loss of $14.

Liquidity and Capital Resources

Net cash used in operating activities

Net cash provided by investing activities

Net cash provided by (used) in financing activities

Net increase (decrease) in cash and cash equivalents

Cash and cash equivalents - beginning of period

Cash and cash equivalents - end of period

Short-term investment securities

Working Capital

As of December 31, 2019, we had positive

working capital of approximately $37.0 million compared to positive working capital of approximately $56.0 million at December

31, 2018, a decrease of approximately $19.0 million.

This decrease in working capital is due a decrease in current assets of approximately

$18.5 million, which is primarily due to a decrease in cash and cash equivalents and short-term investment securities of approximately

$17.4 million, slightly offset by a decrease in current liabilities of approximately $0.6 million.

We used approximately $14.6

million in operating activities during the year ended December 31, 2019.

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.

Cash demands on operations

We had cash and cash equivalents and short-term

investment securities at December 31, 2019 of $38,962,185.

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

During the year ended December 31, 2019, we experienced an operating loss of $23,566,461 (including approximately $1,675,000

in expenses relating to our MRTPA) and used cash in operations of $14,587,364.

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, and investor relations and marketing costs, our monthly cash expenditures are approximately

There may be additional future costs relating to our MRTPA should the FDA require additional studies.

As of December 31, 2020, we had working capital of approximately $20,998 compared to working capital of approximately $36,962 as of December 31, 2019, a decrease of $15,964.

This decrease in working capital was primarily due to a decrease in net current assets of approximately $14,402, as well as an increase in net current liabilities of approximately $1,562.

Cash, cash equivalents and short-term investment securities decreased by approximately $16,620

and the remaining net current assets increased by approximately $2,218.

We used approximately $15,621 of cash in operating activities during the year ended December 31, 2020.

Our cash balance as of December 31, 2020 (inclusive of cash and cash equivalents and short-term investments) was $22,342, a decrease of $16,620 from the cash balance of $38,962 as of December 31, 2019.

This equates to an average monthly cash usage of $1,385 for the year ended December 31, 2020.

Net cash used in operating activities

In the year ended December 31, 2019, $14,587,364

of cash was used in operating activities as compared to $17,844,266 of cash used in operating activities in the year ended December

a decrease of $3,256,901.

The decrease in use of cash in operations was primarily due to the decrease in the cash portion

of the net loss in the amount of $3,947,681, partially offset by an increase in cash used from working capital components related

to operations in the amount of $690,780, for the year ended December 31, 2019 as compared to the year ended December 31, 2018.

The increase in cash used in operations in the amount of $1,033 was due to an increase in cash used for working capital components related to operations in the amount of $2,270 which was partially offset by a decrease in the cash used from the portion of the net loss in the amount of $1,237 for the year ended December 31, 2020 as compared to the year ended December 31, 2019.

The increase in cash used for working capital components was primarily due to an increase in pre-paid D&O insurance, which is described further in Note 8 to our consolidated financial statements, and an increase in accounts receivable due to timing of collections.

Net cash provided by (used in) investing activities

In the year ended December 31, 2019, net cash provided by investing

activities was $4,551,933 as compared to $15,145,044 of cash provided by investing activities during the year ended December 31,

During the year ended December 31, 2019 the cash provided by investing activities consisted of net cash provided by transactions

relating to our short-term investment account in the amount of $17,478,448, and proceeds from the sale of machinery and equipment

in the amount of $166,150, partially offset by cash used in the acquisition of patents and trademarks, machinery and equipment

and a cigarette predicate license agreement in the amount of $1,092,665 and by the equity and debt investment in Panacea of $12,000,000.

During the year ended December 31, 2018 the cash provided by investing activities consisted of net cash provided from our sale

of the common stock of Aurora in the amount of $13,051,503 and net cash provided by transactions relating to our short-term investment

account in the amount of $3,199,165, partially offset by cash used in the acquisition of patents and trademarks and machinery and

equipment in the amount of $1,105,624.

The increase in cash provided by investing activities, in the amount of $11,917 when compared to the prior year was primarily attributed to the 2019 acquisition of Panacea which totaled $12,000.

In addition, cash flows decreased for the acquisition of patents and trademarks, machinery and equipment in the net amount of $570.

These increased cash inflows were partially offset by a decrease in the net proceeds received from our short term investments in the amount of $493 and decreased proceeds from the sale of machinery and equipment in the amount of $160.

Net cash provided by (used in) financing activities

During the year ended December 31, 2019, we realized $9,915,617

in proceeds from our financing activities resulting from net proceeds from the exercise of warrants in the amount of $10,615,617, partially

offset by payments on notes payable in the amount of $700,000 .

During the year ended December 31, 2018,

we used $355,387 in our financing activities as a result of payments on notes payable in the amount of $800,000, offset by net

cash proceeds received from the exercise of stock options in the amount of $444,613.

Contractual Obligations

The following table summarizes by category

our expected future cash outflows associated with contractual obligations in effect at December 31, 2019:

Payments Due by Period

Notes payable

Operating lease obligations (1)

Consulting agreements

What changed 10-K

Item 7. Management’s Discussion and Analysis