Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
This discussion should be read in conjunction with the other sections of this Form 10-K, including “Risk Factors,” and the Financial Statements and notes thereto. 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. Ms. Sullivan has served as a director of 22nd Century Group since May 18, 2015. Ms. 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.
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● On June 3, 2020, we appointed James A. Mish as our Chief Executive Officer and John Franzino as our Chief Financial Officer. Mr. 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. Dr. 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. V. 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.
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● 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. patent, No. 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.
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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. Patent No. 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
1. 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.
2. 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.
3. 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.
4. 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.
5. We will maintain diligent financial execution, efficient operating structure, and balance sheet strength to support our growth initiatives.
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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
Year Ended
December 31
December 31
2020
2019
Sale of products, net
$
28,111
$
25,833
Dollar Change from Prior Year
$
2,278
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)
Year Ended
December 31
December 31
2020
2019
Cost of goods sold
$
26,673
$
25,818
Percent of Product Sales
94.9
%
99.9
%
Dollar Change from Prior Year
$
855
Year Ended
December 31
December 31
2020
2019
Gross profit (loss)
$
1,438
$
15
Percent of Product Sales
5.1
%
0.1
%
Dollar Change from Prior Year
$
1,423
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
Year Ended
December 31
December 31
2020
2019
Research and Development
$
4,090
$
6,381
Percent of Product Sales
14.5
%
24.7
%
Dollar Change from Prior Year
$
(2,291)
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
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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
Year Ended
December 31
December 31
2020
2019
Research and Development - MRTP
$
38
$
1,679
Percent of Product Sales
0.1
%
6.5
%
Dollar Change from Prior Year
$
(1,641)
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
Year Ended
December 31
December 31
2020
2019
Sales, general and administrative
$
14,971
$
12,954
Percent of Product Sales
53.3
%
50.1
%
Dollar Change from Prior Year
$
2,017
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
Year Ended
December 31
December 31
2020
2019
Impairment of intangible assets
$
176
$
1,142
Percent of Product Sales
0.6
%
4.4
%
Dollar Change from Prior Year
$
(966)
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.
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Depreciation expense
Year Ended
December 31
December 31
2020
2019
Depreciation
$
688
$
589
Percent of Product Sales
2.4
%
2.3
%
Dollar Change from Prior Year
$
99
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
Year Ended
December 31
December 31
2020
2019
Amortization
$
658
$
836
Percent of Product Sales
2.3
%
3.2
%
Dollar Change from Prior Year
$
(178)
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
Year Ended
December 31
December 31
2020
2019
Unrealized gain (loss) on investments
$
(434)
$
(2,419)
Percent of Product Sales
(1.5)
%
(9.4)
%
Dollar Change from Prior Year
$
1,985
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
Year Ended
December 31
December 31
2020
2019
Impairment of Panacea Investment
$
(1,741)
$
—
Percent of Product Sales
(6.2)
%
—
%
Dollar Change from Prior Year
$
(1,741)
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.
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Realized gain (loss) on short-term investment securities
Year Ended
December 31
December 31
2020
2019
Realized gain (loss) on short-term investment securities
$
5
$
221
Percent of Product Sales
0.0
%
0.9
%
Dollar Change from Prior Year
$
(216)
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 $1,891 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
Year Ended
December 31
December 31
2020
2019
Gain on the sale of machinery and equipment
$
1
$
87
Percent of Product Sales
—
%
0.3
%
Dollar Change from Prior Year
$
(86)
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
Year Ended
December 31
December 31
2020
2019
Interest Income, net
$
1,751
$
1,066
Percent of Product Sales
6.2
%
4.1
%
Dollar Change from Prior Year
$
685
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
Year Ended
December 31
December 31
2020
2019
Interest Expense
$
(72)
$
(56)
Percent of Product Sales
(0.3)
%
(0.2)
%
Dollar Change from Prior Year
$
(16)
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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.
Net loss
Year Ended
December 31
December 31
2020
2019
Net Loss
$
(19,711)
$
(26,558)
Percent of Product Sales
(70.1)
%
(102.7)
%
Dollar Change from Prior Year
$
6,847
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
Year Ended
December 31
December 31
2020
2019
Other Comprehensive Income (Loss)
$
67
$
(14)
Percent of Product Sales
0.2
%
(0.1)
%
Dollar Change from Prior Year
$
81
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
Year-to-Date
December 31
December 31
2020
2019
Net cash used in operating activities
$
(15,621)
$
(14,588)
Net cash provided by investing activities
16,469
4,552
Net cash provided by (used) in financing activities
(304)
9,916
Net increase (decrease) in cash and cash equivalents
544
(120)
Cash and cash equivalents - beginning of period
485
605
Cash and cash equivalents - end of period
$
1,029
$
485
Short-term investment securities
$
21,313
$
38,477
Working Capital
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
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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
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
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, 2020, cash used in by financing activities was $304 primarily due to principal payments on our notes payable of $2,549 which was partially offset by $2,195 of proceeds received from a note payable issuance. Refer to Note 8 to our consolidated financial statements for additional information.
During the year ended December 31, 2019, we realized $9,916 in proceeds from our financing activities resulting from net proceeds from the exercise of warrants in the amount of $10,616, partially offset by payments on notes payable in the amount of $700 .
Cash demands on operations
Our principal sources of liquidity are our cash and cash equivalents, short-term investment securities, and cash generated from our contract manufacturing business. As of December 31, 2020, we had approximately $22,342 of cash and cash equivalents and short-term investments which is a decline of $16,620 from December 31, 2019. During 2020, our average monthly cash usage was approximately $1,385, compared to $1,449 in 2019. Our short-term investment securities along with sustained contract manufacturing sales provide sufficient resources for estimated contractual commitments for 2021, described further in Note 12 to our consolidated financial statements, and normal cash requirements for operations. In addition to the commitments described in Note 12 to our consolidated financial statements, we are currently in the process of securing contracts with select tobacco farmers to assist with the 2021 growing of our VLNC tobacco. These contacts, once finalized and executed, will increase the quantity of our current leaf inventory which will help support expected demand of VLN ® , if MTRP authorization is granted by the FDA. The cost of such growing efforts is dependent on the final agricultural yields and leaf quality, but we expect the cost to range between $1.5 million and $1.9 million.
We also believe that we have appropriate liquidity to successfully manufacture and distribute our VLN ® cigarette within 90 days of MRTP authorization by the FDA, if granted in 2021.
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 $9,993. On March 10, 2021, our warrant holders exercised for cash the remaining 1,715,599 outstanding warrants and no outstanding warrants remain. We also have an effective S-3 shelf registration statement on file with the U.S. Securities and Exchange Commission (SEC),
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which provides us flexibility and optionality to raise capital, however there can be no assurance that capital will be available to us on acceptable terms or at all.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) which requires management to make estimates, judgements, and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. For a discussion of our significant accounting policies, refer to Note 1 to our consolidated financial statements. We believe that our most critical accounting estimates relate to investment valuation and impairment of long-lived intangible assets.
Investment Valuation –We have two investments—our investment in Panacea Life Sciences, Inc. (“Panacea”) and Aurora Cannabis, Inc. (“ACB”)—that require us to estimate fair value and assess for impairment indicators as of each period-end. Our investment in Aurora consists of stock warrants that are exercisable into common stock at a predetermined exercise price. We estimate the Aurora stock warrant fair value using the Black-Scholes pricing model noting one unobservable input—an estimated volatility factor based on the underlying stock price of ACB. Therefore, changes in market volatility will impact the fair value measurement for our investment.
Our investment in Panacea includes three instruments: Series B preferred stock (“preferred stock”), a convertible note receivable, and a stock warrant to purchase additional shares of Series B preferred stock. The preferred stock and convertible note receivable are recorded as available-for-sale debt securities, while the stock warrant is recorded at its cost basis in accordance with the practicability exception under ASU 2016-01. We consider the current market conditions of the cannabidiol (“CBD”) consumer product industry, competition, governmental regulation developments, our preferred stock priority equity preferences and rights, and the overall finance performance of Panacea to assess if fair value supports our investment carrying value.
Refer to Note 6 and Note 7 to our consolidated financial statements for additional information regarding our investment valuations.
Impairment of Long-Lived Assets – Our intangible asset portfolio consists of both definite-lived and indefinite-lived intangible assets which include patents, trademarks, licenses, and our inclusion within the tobacco master settlement agreement (“MSA”). Our intangible assets subject to amortization are reviewed for strategic importance and commercialization opportunity prior to expiration. If it is determined that the asset no longer supports the Company’s strategic objectives and/or will not be commercially viable prior to expiration, the asset is impaired. To determine if an asset’s carrying value is appropriate, we are required to estimate the expected commercialization of our tobacco and cannabis intellectual property—either through future product sales or potential license opportunities. This estimate process includes expected future cash flow projections, industry market assessments, and assumptions around positive regulatory developments from government agencies—including authorization of our MRTPA.
For our indefinite-lived intangible assets—MSA and cigarette brand predicate—we consider current and future sales projections, strategic objectives, future market and economic conditions, competition, and federal and state regulations to determine if it is more likely than not that that the asset is impaired. If it is more likely than note that the asset is impaired, we will compare the asset carrying value to fair value.
Management has discussed these critical accounting policies and estimates with the Audit Committee of the Company’s Board of Directors. While our estimates and assumptions are based on our knowledge of current events and future actions, actual results may ultimately differ from these estimates and assumptions.
Inflation
Inflation did not have a material effect on our operating results for the years ended December 31, 2020 and 2019.
Off-Balance Sheet Arrangement
We do not have any off-balance sheet arrangements as defined by Item 303(a)(4) of Regulation S-K.
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