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. The various sections of this discussion contain a number of forward-looking statements, all of which are based on our current expectations and could be affected by the uncertainties and risk factors described throughout this Annual Report on Form 10-K. See “Cautionary Note Regarding Forward-Looking Statements and Risk Factor Summary.” Our actual results may differ materially. For purposes of this Management’s Discussion and Analysis of Financial Condition and Results of Operations, references to the “Company,” “we,” us” or “our” refer to the operations of 22nd Century Group, Inc. and its direct and indirect subsidiaries for the periods described herein.
($ in thousands, except per share data or unless otherwise specified)
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Executive Overview
● Executive overview
● Recent business acquisitions
● Tobacco business highlights
● Hemp/cannabis business highlights
● Corporate business highlights
● Financial overview
Our Financial Results
● Fiscal 2022 compared with fiscal 2021
● Liquidity and capital resources
● Impact of recently issued accounting standards
Critical Accounting Estimates
● Inventories
● Valuation of long-lived assets
● Business combinations
Executive Overview
● On December 23, 2021, the FDA granted MRTP authorization for our reduced nicotine cigarettes, VLN ® King and VLN ® Menthol King. In addition to authorizing the Company to market VLN ® cigarettes with the claim, “95% less nicotine”, to clarify the purpose of the brand, the FDA also authorized the claim, “Helps You Smoke Less.”
● Commenced pilot market sales in Chicago during the first quarter of 2022 of VLN ® King and VLN ® Menthol King 95% reduced nicotine content cigarettes, the first and only FDA authorized MRTP designated combustible cigarettes.
● Based on strong pilot outcomes, announced plans for the expansion of VLN ® into additional Illinois locations and the Colorado market as of September 2022. The Company also announced that it will launch VLN ® in three additional states – Arizona, New Mexico, and Utah – covering the Four Corners region.
● Contracted the largest VLN ® tobacco planting in 2022 to support expansion in both the U.S. and international markets.
● Announced an industry-first breakthrough in hemp/cannabis plant transformation with our partner KeyGene, expanding the Company’s capabilities in modifying the principal genes controlling cannabinoid biosynthesis in the plant.
Recent Business Acquisitions and Other Events
● On May 13, 2022, we completed the acquisition of GVB Biopharma ("GVB"), a privately held contract development and manufacturing organization (CDMO). We believe GVB is one of the largest providers of hemp-derived active ingredients for the pharmaceutical and consumer goods industries worldwide based on total tonnage. GVB has industry leading market positions and expertise in all facets of the hemp/cannabis industry, including: research and genetics, proprietary cryogenic hemp extraction; refining, conversion, and product formulation technology; lead supplier of Active Pharmaceutical Ingredients (API); low-cost, scalable manufacturing capabilities; regulatory and compliance expertise; industry trusted high-quality products; and international capabilities
● On November 20, 2022, a fire occurred at the GVB Biopharma distillate and isolate manufacturing facility located in Grass Valley, OR. There were no reported life-threatening injuries, but the fire damaged the refinement facility requiring all hemp refining operations on site to be curtailed. Additional equipment and inventory stored in adjacent buildings was not damaged and was relocated to nearby facilities as part of the Company's business continuity plans. The Company subsequently commenced the insurance claims process and believes that losses resulting from the fire will be covered by its property and business interruption policies. Subsequent to the fire, the Company implemented backup sourcing and production plans to continue fulfilling customer orders and to resume production of distillate and isolate ingredients.
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● On January 19, 2023, we acquired RX Pharmatech Ltd (“RXP”), a privately held leading United Kingdom distributor of cannabinoids with 1,276 novel food applications with the U.K. Food Standards Agency (“FSA”). RXP’s products include CBD isolate and numerous variations of finished products like gummies, oils, drops, candies, tinctures, sprays, capsules and others. The U.K. is not accepting new novel food applications for cannabinoid products at this time and denied tens of thousands of product applications earlier in 2022 during the FSA’s first round of screening. Accordingly, we believe this market dynamic could allow us to open new opportunities to land highly accretive contracts with multinationals for quality CBD and hemp-derived consumer products dependent on the novel food licenses.
Refer to Note 2 “Business Acquisitions” and Note 21 “Subsequent Events” of the Notes to Consolidated Financial Statements contained in Item 8 of this report for additional information about the acquisition of GVB and RXP.
Tobacco Business Highlights
● Leveraged the exceptional Chicago pilot results to expand VLN ® sales in Illinois and launch in Colorado, where the state employs a favorable MRTP excise tax program. Announced additional launch plans in Arizona, New Mexico and Utah.
● Commenced an aggressive multi-state VLN ® rollout strategy, targeting up 18 states by year-end 2023, aimed at penetrating geographies and markets with large adult smoker populations, including those with favorable MRTP state excise tax savings, which can be used toward consumer incentives, distribution support, and additional programming to raise awareness of VLN ® products.
● Initiated agreements with national-scale C-store distribution partners, including Core-Mark/Eby-Brown and others pending, to facilitate state-wide or multi-state launches of VLN ® at hundreds of stores within our target markets in an accelerated timeline.
● Announced expansion into Texas, California and Florida, expected in conjunction with the largest multi-state U.S. C-store chain leveraging these new national scale distribution capabilities.
● Secured additional retail point of sale placements with regional C-stores, such as Texas based CEFCO, and new regional distribution agreements with Hub, Inc., serving regional Midwestern and tribal accounts, and Chambers & Owen, Inc., serving the upper Midwest.
● Gained authorization to test VLN ® sales at four United States military bases located in California, Arizona and North Carolina, beginning in the second quarter.
● Poised to benefit from federal, state and international regulatory appetite for banning menthol and mandating reduced nicotine content. The Company has the only FDA-authorized combustible cigarette able to meet the stringent reduced nicotine content product standard under the FDA’s Comprehensive Plan requiring that all cigarettes be made “minimally or non-addictive.”
o Proposed FDA menthol cigarette ban , in final rules status, could leave VLN ® Menthol King as the only combustible menthol cigarette on the market , providing a critical off-ramp to help current menthol smokers to smoke less , a final decision expected in August 2023.
o In December 2022, New Zealand became the first country to pass a nationwide mandate permitting only reduced nicotine content cigarettes to be sold starting in early 2025.
● Planted the largest ever VLN ® tobacco crop in 2022, including the second-generation VLN ® 2.0 reduced nicotine tobacco plants, which have demonstrated approximately 30% higher yields, enhanced quality leaf, improved disease resistance, reduction in nutrient requirements and increased stability across various environments and geographies.
o Announced a dedicated seed cultivation program designed to generate enough tobacco to support the entire New Zealand cigarette marketplace with reduced nicotine content tobacco, more than 2 billion sticks annually.
● Completed expansion of existing manufacturing operations and increased capacity by 25%, including installation of a new production line and initiation of a second shift.
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Hemp/Cannabis Business Highlights
● Fundamentally shifted hemp/cannabis business, moving from primarily research and development efforts to a fully commercialized company with the acquisition of GVB Biopharma, a global scale provider of hemp-derived cannabinoid ingredients and API to the pharmaceutical and consumer goods industries with world-class CDMO capabilities.
● Positioned for global leadership as the largest provider of cannabinoid extracts and isolates in North America, focused on cannabidiol (CBD) and cannabigerol (CBG) extracted and refined at industrial scale into distillates.
● Completed vertical integration of novel cannabinoid value chain from receptor science to finished goods and now CDMO+D capabilities for complete category management to retail points of sale.
● Advancing multiple verticalized license agreements with major consumer CBD and alternative cannabinoid brands to manufacture and distribute key cannabinoid product offerings to retailers throughout the U.S. as a new turnkey solution for consumer facing cannabis product brands.
● Continued expanding CBD crude production capabilities with new Prineville, Oregon facility, one of the largest hemp extraction plants in the world, with expected capacity exceeding 15,000 kg/month at full operation, further improving gross margin on all GVB cannabinoid products.
● Responded to a fire at the Company’s Grass Valley manufacturing facility, immediately shifting to alternate supply sources to fulfill all customer deliveries planned in the fourth quarter. New facilities are being established, replacing the prior capacity, as the Company plans for construction of a new, larger and more efficient distillate and isolate manufacturing campus.
● Submitted DMF to the FDA to produce and supply APIs for the medical and pharmaceutical industries while also pursuing The International Council for Harmonization of Technical Requirements for Pharmaceuticals for Human Use (ICH) Q7 international pharma-grade audit standard certification in order to supply naturally derived hemp/cannabis APIs.
● Announced a global sales, marketing and distribution agreement with Cannabinoid API Solutions (CAS) and Transo-Pharm for APIs to accelerate opportunities to supply to the largest and most innovative pharmaceutical and consumer goods manufacturers.
● Acquired RX Pharmatech Ltd. in an accretive transaction securing a portfolio of 1,276 CBD product and ingredient based Novel Food Applications with the U.K. Food Standards Agency, accelerating CBD product growth in the U.K. and EU food and nutraceuticals markets.
● Announced the Company’s central distribution facility in the Netherlands, opened in November 2022, will support growing demand for hemp/cannabis products in Europe, the Middle East, and Africa (EMEA).
Corporate Business Highlights
● Dr. Calvin Treat joined the Company as our Chief Scientific Officer on May 23, 2022, further enhancing our deep expertise in plant-based biotechnology across all three of our plant franchises. Dr. Treat has led global plant biotechnology programs at Bayer and Monsanto, including corn, soybean, and cotton crop improvement technologies.
● R. Hugh Kinsman was appointed Chief Financial Officer on June 16, 2022, expanding his role at GVB Biopharma to include corporate financial leadership functions.
● The Company announced that the position of President and Chief Operating Officer was eliminated effective September 30, 2022. James A. Mish, assumed the responsibilities of Corporate President, and operations have been integrated into the tobacco and hemp/cannabis business teams.
● Lucie S. Salhany was appointed to the Company’s Board of Directors in September 2022, extending her experience in positioning unique products for successful launch, corporate strategy, and entrepreneurial ventures to help raise 22nd Century’s profile in tobacco harm reduction and the hemp/cannabis industry.
● The Company announced that John Miller was appointed as an executive officer and President of Tobacco effective November 11, 2022. John J. Miller initially joined our tobacco business in May 2022, to help achieve the full potential of our tobacco franchise. Mr. Miller was the President and CEO of Swisher International, Inc., the largest manufacturer and exporter of cigars and smokeless tobacco products in America.
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Financial Overview – Fourth Quarter and Full Year 2022 Results
● Net revenues for the fourth quarter of 2022 were $19,206, an increase of 141.3% from $7,960 in 2021.
o Revenue from tobacco-related products was $9,951, an increase of 25.7% from 2021, primarily driven by volume increases in contract manufacturing and initial VLN ® sales as part of the early rollout in Illinois and Colorado.
● Fourth quarter 2022 cartons sold of 1,354 compared to 1,144 in the comparable prior year period.
o Revenue from hemp/cannabis-related products was $9,255, compared to $43 in the prior year fourth quarter, reflecting the acquisition of GVB.
● Net revenues for the full year 2022 were $62,111, an increase of 100.7% from $30,948 in 2021.
● Gross profit for the fourth quarter of 2022 was a loss of $646 compared to profit of $231 in the prior year period.
o Gross profit from tobacco-related products was $(44), a decrease of $400 compared to the prior year period, reflecting lower margin sales mix in contract manufacturing products.
o Gross profit from hemp/cannabis-related products was a loss of $(601) compared to $(125) in the prior year. Margin declines in the fourth quarter were primarily due to impact of the Grass Valley fire. On a proforma basis, as if the GVB acquisition had occurred effective January 1, 2021, gross profit would have been $1,594 in the fourth quarter 2021.
● Gross profit for the full year 2022 was $1,174, a decrease of 21.0% from 2021.
● Total operating expenses for the fourth quarter 2022 increased to $22,512 compared to $9,262 in the prior year quarter driven by:
o Sales, general and administrative expenses increased to $14,097 driven primarily by the acquisition of GVB, higher strategic consulting and marketing, legal, and personnel costs to expand the launch of VLN ®
o Research and development expenses increased to $2,093, driven by personnel expenses and costs associated with the Company’s hemp/cannabis and hops research programs.
o Other operating expenses, net was $6,322 reflecting the unusual and infrequent charges recorded in connection with the Grass Valley fire in November 2022.
● Operating loss for the fourth quarter 2022 was $23,158, compared to a loss of $9,031 in the prior year period. Operating loss for the full year 2022 was $57,106, compared to a loss of $28,412 in the prior year.
● Net loss in the fourth quarter of 2022 was $26,283, representing a net loss per share of $0.12 compared with net loss in the fourth quarter of 2021 of $13,964, representing a net loss per share of $.09. Net loss for the full year 2022 was $59,801, representing a net loss per share of $0.31 compared with net loss for the full year 2021 of $32,609, representing a net loss per share of $.21.
● As of December 31, 2022, we had $21,213 in cash, cash equivalents and short-term investments securities.
o During the first quarter of 2023, the Company received $5,000 of casualty loss insurance recoveries from the Grass Valley fire with business interruption insurance claims proceeds expected thereafter.
o On March 3, 2023, the Company announced a $21,052 senior credit facility to fund increased working capital needs related to the significant consumer demand for its VLN ® product and GVB business lines.
◾ The new three-year credit facility was issued at 5% original issuance discount (OID), will bear cash interest at a rate of 7% per annum, and commence principal amortization in the
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second year at a rate of 2% of the original balance per month. The Company has the option to redeem the facility early starting in the second year.
● The Company’s strengthened balance sheet supports growing working capital needs driven by increased VLN ® product shipments to multiple national-scale distribution partners as well as strong customer demand for hemp/cannabis bulk ingredients.
● 22nd Century’s operating cash requirements are anticipated to decrease through fiscal 2023, reflecting higher sales volume of higher margin contract manufacturing operations (CMO) cigarettes and VLN ® products, as well as continued organic growth of GVB’s operations.
Our Financial Results
The following table presents selected financial information derived from our Consolidated Financial Statements, contained in Item 8 of this report, for the periods presented (dollars in thousands, except per share amounts):
Year Ended
December 31
December 31
Change
2022
2021
$
%
Tobacco revenues, net
$
40,501
$
30,905
$
9,596
31.0
Hemp/cannabis revenues, net
21,610
43
21,567
NM
Total revenues, net
62,111
30,948
31,163
100.7
Cost of goods sold
60,937
29,462
31,475
106.8
Gross profit
1,174
1,486
(312)
(21.0)
Gross profit as a % of revenues, net
1.9
%
4.8
%
Operating expenses:
Sales, general and administrative ("SG&A")
44,517
25,908
18,609
71.8
SG&A as a % of revenues, net
71.7
%
41.7
%
Research and development ("R&D")
6,561
3,912
2,649
67.7
R&D as a % of revenues, net
10.6
%
6.3
%
Other operating expenses, net ("OOE")
7,202
78
7,124
9,170.4
Total operating expenses
58,280
29,898
28,382
94.9
Operating loss
(57,106)
(28,412)
(28,694)
101.0
Operating loss as a % of revenues, net
(91.9)
%
(45.7)
%
Other income (expense):
Unrealized loss on investment
(5)
(6,994)
6,989
(99.9)
Realized (loss) gain on Panacea investment
(2,789)
2,548
(5,337)
(209.5)
Realized loss on short-term investment securities
(366)
-
(366)
NM
Other income, net
71
-
71
NM
Interest income, net
313
321
(8)
(2.5)
Interest expense
(353)
(58)
(295)
503.9
Total other expense
(3,129)
(4,183)
1,054
(25.2)
Loss before income taxes
(60,235)
(32,595)
(27,640)
84.8
(Benefit) provision for income taxes
(434)
14
(448)
(3,196.5)
Net loss
$
(59,801)
$
(32,609)
(27,192)
83.4
Net loss as a % of revenues, net
(96.3)
%
(52.5)
%
Net loss per common share (basic and diluted)
$
(0.31)
$
(0.21)
(0.10)
48.6
NM - calculated change not meaningful
Refer to Note 17, “Segment and Geographic Information,” of the Notes to Consolidated Financial Statements contained in Item 8 of this report for additional information regarding operating results for our two operating and reportable segments: (1) Tobacco, (2) Hemp/cannabis.
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Fiscal 2022 Compared with Fiscal 2021
Revenue - Sale of products, net
Year Ended
December 31
December 31
Change
2022
2021
$
%
Tobacco
$
40,501
$
30,905
$
9,596
31.0
Hemp/cannabis
21,610
43
21,567
NM
Total revenues, net
$
62,111
$
30,948
31,163
100.7
The increase in revenue for the year ended December 31, 2022, compared to the year ended December 31, 2021, was primarily the result of an increase in tobacco revenue of $9,596 or 31.0% from 2021 primarily driven by volume increases in the number of cartons sold. Full year 2022 cartons sold were of 5,782 compared to 4,331 in the comparable prior year period.
H emp/cannabis revenue was $21,567 in the current year compared to negligible revenues in 2021, primarily as a result of the GVB acquisition .
Gross profit
Year Ended
December 31
December 31
Change
2022
2021
$
Gross profit
$
1,174
$
1,486
(312)
Percent of Revenues, net
1.9
%
4.8
%
The decrease in gross profit and gross profit as a percent of revenues, net for the year ended December 31, 2022, compared to the year ended December 31, 2021, was primarily driven by an increase of $218 from favorable tobacco volume offset by losses from hemp/cannabis of $530. Hemp/cannabis gross profit was unfavorable mainly due to non-recurring charges of $1,259, primarily attributable to amortization of inventory step-up resulting from the acquisition of GVB. Additionally, hemp/cannabis gross profits in the fourth quarter were negatively impacted from the Grass Valley fire. We anticipate subsequent recoveries in 2023 of gross profit negatively impacted by the fire through our business interruption insurance claims.
Sales, general and administrative expense
Change 2022 vs 2021
$
%
Compensation and benefits (a)
$
2,922
24.9
Legal (b)
497
48.7
Strategic consulting (c)
4,994
63.9
Sales and marketing (d)
1,305
412.9
Other (e)
1,099
22.0
GVB (f)
7,793
100.0
Net increase in SG&A expenses
$
18,609
71.8
(a) Increases in compensation and benefits primarily due to $716 increased headcount mainly due to the increase in selling and marketing personnel driven by the ongoing expansion and accelerated launch of VLN ® , $1,486 increase in equity comp ($1,237 related to accelerated vesting of an employee’s outstanding equity awards as part of the termination severance agreement), and an increase of $615 in severance.
(b) Increased legal expenses due to regulatory compliance for VLN ® launch, and enforcement of our patent portfolios.
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(c) Increase of strategic consulting due to additional business development, recruitment, and investor relations expenses.
(d) Increases due to the ongoing expansion and accelerated launch of VLN ® .
(e) Other expenses increased due to $529 of travel and entertainment, $239 of technology expenses, $215 in public accounting fees, and other $335 offset by a decrease in insurance expenses of $219.
(f) Increased SG&A as a result of the acquisition of GVB on May 13, 2022, including corporate personnel costs and general overhead.
Research and development expense
Change 2022 vs 2021
$
%
Compensation and benefits (a)
$
438
72.3
Contract costs (b)
1,250
56.9
Consulting and professional services (c)
526
630.7
Other (d)
325
31.7
GVB (e)
110
100.0
Net increase in R&D expenses
$
2,649
791.6
(a) Increased compensation and benefits related to the additional executive and R&D personnel in the current year.
(b) Increased expenses due to our contracts related to field trials, hemp/cannabis programs, new hops R&D and royalty fees.
(c) Increased consulting to evaluate strategic opportunities related to our tobacco patent portfolio.
(d) Other increases include facilities expenses from our new Maryland lab, amortization expenses of new patents, increased patent maintenance costs and testing costs.
(e) Increased R&D as a result of the acquisition of GVB on May 13, 2022.
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Other operating expenses, net
Year Ended
December 31,
2022
2021
Grass Valley fire:
Fixed asset write-offs
$
5,550
$
-
Inventory charges
3,998
-
Compensation & benefits
195
-
Professional services
36
-
Lease obligations
20
-
Insurance recoveries
(5,000)
-
Total Grass Valley fire (a)
4,799
-
Acquisition costs (b)
1,046
-
Impairment of intangible assets (c)
1,488
78
Impairment of inventory (c)
237
-
(Gain) loss on sale or disposal of property, plant and equipment (d)
(368)
-
Total other operating expenses, net
$
7,202
$
78
(a) In November 2022, there was a fire at our Grass Valley manufacturing facility in Oregon, which manufactures bulk ingredients, primarily CBD isolate and distillate. The total charges of $9,799 were offset by $5,000 of insurance proceeds.
(b) Acquisition costs attributable to the acquisition of GVB on May 13, 2022.
(c) Other general charges include impairment of intangible assets that no longer meet the Company’s strategic objectives and inventory impairment as a result of unavoidable casualty from a weather event.
(d) Reflects gain on sale resulting from sale of older tobacco manufacturing equipment.
Refer to Note 19, “Other operating expenses, net,” of the Notes to Consolidated Financial Statements contained in Item 8 of this report for additional information regarding these charges.
Other income (expense)
Year Ended
December 31
December 31
Change
2022
2021
$
%
Other income (expense):
Unrealized loss on investment (a)
$
(5)
$
(6,994)
$
6,989
(99.9)
Realized (loss) gain on Panacea investment (b)
(2,789)
2,548
(5,337)
(209.5)
Realized loss on short-term investment securities
(366)
-
(366)
NM
Other income, net
71
-
71
NM
Interest income, net
313
321
(8)
(2.5)
Interest expense (c)
(353)
(58)
(295)
503.9
Total other expense
$
(3,129)
$
(4,183)
$
1,054
(25.2)
NM - calculated change not meaningful
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(a) Unrealized loss on investment includes fair value adjustments for our investment in Panacea Life Sciences Holdings, Inc. (“PLSH”) during the year ended December 31, 2021 and Aurora Cannabis Inc (“Aurora”) stock warrants during the years ended December 31, 2022 and 2021, respectively.
(b) Realized (loss) gain on PLSH investment reflects the change in fair value and write-off of our investment in PLSH common stock during the year ended December 31, 2022 of $2,340 and extinguishment of note receivable of $500 less adjusted discount of $51.
(c) Interest expense increased in 2022, as compared to the prior year period, primarily due to the interest recognized from the GVB bridge notes resulting from the GVB acquisition.
Liquidity and Capital Resources
December 31
December 31,
2022
2021
Cash and cash equivalents
$
3,020
$
1,336
Short-term investment securities
$
18,193
$
47,400
Working capital
$
31,587
$
45,958
Cash, cash equivalents and short-term investment securities decreased by $27,523 primarily as a result of cash used in operating activities, offset by net proceeds from issuance of common stock in July 2022 described below.
Working Capital
As of December 31, 2022, we had working capital of approximately $31,587 compared to working capital of approximately $45,958 as of December 31, 2021, a decrease of $14,371. This decrease in working capital was primarily due to increases from normal fluctuations of current assets such as inventory (i.e. tobacco leaf grow) and an increase of $11,897 attributable to GVB, offset by a decrease of $27,523 in cash, cash equivalents and short-term investment securities.
Summary of Cash Flow
Year Ended
December 31,
2022
2021
Cash provided by (used in):
Operating activities
$
(51,714)
$
(22,839)
Investing activities
22,578
(27,729)
Financing activities
30,820
50,875
Net change in cash and cash equivalents
$
1,684
$
307
Net cash used in operating activities
Cash used in operations increased $28,875 from $22,839 in 2021 to $51,714 in 2022. The primary driver for this increase was higher net loss of $27,192, driven by increased spending in SG&A and R&D both from the acquisition of GVB and acceleration of the launch of VLN ® , an increase of $9,154 related to net adjustments to reconcile net loss to cash, and an increase in cash used for working capital components related to operations in the amount of $10,837 for the year ended December 31, 2022, as compared to the year ended December 31, 2021.
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Net cash provided by (used in) investing activities
Cash provided by investing activities amounted to $22,578 in 2022 as compared to cash used in investing activities of $27,729 in 2021. The decrease in cash used in investing activities of $50,307 was primarily the result of a net increase in the net cash provided by our short-term investments in the amount of $55,235 offset by an increase in the cash used for acquisition of property, plant and equipment, the acquisition of patents, trademarks and licenses, acquisition of GVB and investment in Change Agronomy Ltd. in the amount of $3,358 for the year ended December 31, 2022 compared to the year ended December 31, 2021.
Net cash provided by financing activities
During the year ended December 31, 2022, cash provided by financing activities decreased by $20,055 resulting from (i) the net proceeds of $11,782 resulting from cash exercises of all outstanding warrants in 2021 that did not occur in 2022; (ii) the change in net proceeds of issuance of common stock of $5,722; (iii) the change in net proceeds pertaining to notes payable issuances and payments of $1,709; (iv) change in net proceeds from stock option exercises of $1,133. These decreases were partially offset by the change in cash paid for taxes related to settlement of restricted stock units of $320.
Cash demands on operations
Our principal sources of liquidity are our cash and cash equivalents, short-term investment securities, cash generated from our tobacco contract manufacturing business and hemp/cannabis business and proceeds from debt and equity financing activities. As of December 31, 2022, we had approximately $21,213 of cash and cash equivalents and short-term investments, and $5,000 insurance recovery receivable related to the Grass Valley fire, which we anticipate collecting in the first half of 2023. We have additional business interruption coverage with policy limits of up to $15,000, which we continue pursuing in connection with such incident.
As described below, on July 25, 2022, we completed a $35,000 above-market registered direct offering with institutional investors generating net proceeds of $32,484, and on March 3, 2023 we entered into a $21,052 senior secured credit facility generating net proceeds to us of approximately $20,000. Proceeds from these financing activities are intended to be used to continue with the launch of our VLN ® products and to meet increased GVB customer demands and volume.
Our cash, cash equivalents, short-term investment securities, insurance recovery proceeds, and credit facility financing, as well as the sustained tobacco contract manufacturing and hemp/cannabis sales, will provide sufficient resources for estimated contractual commitments, described further in Note 12 to our Consolidated Financial Statements included herein, and normal cash requirements for operations well beyond the next twelve months. We are selectively deploying capital to accelerate the launch of VLN ® , expand tobacco manufacturing operations, invest in GVB’s production capacity and increase inventory levels to meet growing demand for both hemp/cannabis and tobacco products and for research and development. Our cash requirements in future periods are anticipated to decrease, reflecting higher sales volume for VLN ® products through fiscal 2023 and continued organic growth of hemp/cannabis operations, providing adequate liquidity from the current balance sheet to complete our planned strategic initiatives.
New Senior Secured Credit Facility
On March 3, 2023, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with each of the purchasers party thereto (each, including its successors and assigns, a “Purchaser” and collectively, the “Purchasers”) and JGB Collateral, LLC, a Delaware limited liability company, as collateral agent for the Purchasers (the “Agent”). Pursuant to the Purchase Agreement, the Company agreed to sell to the Purchasers (i) 5% Original Issue Discount Senior Secured Debentures (the “Debentures”) with an aggregate principal amount of $21,052,632 and (ii) warrants to purchase up to 5,000,000 shares of the Company’s common stock, par value $0.00001 per share (the “Common Stock”), for an exercise price of $1.275 per share, a 50% premium to the VWAP on the closing date (the “JGB Warrants”), subject to adjustments as set forth in the JGB Warrants, for a total purchase price of $20,000,000.
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The Debentures bear interest at a rate of 7% per annum, payable monthly in arrears as of the last trading day of each month and on the maturity date. The Debentures mature on March 3, 2026. At the Company’s election, subject to certain conditions, interest can be paid in cash, shares of the Company’s common stock, or a combination thereof. The Debentures are subject to an exit payment equal to 5% of the original principal amount, or $1,052,632, payable on the maturity date or the date the Debentures are paid in full (the “Exit Payment”). Any time after, March 3, 2024, the Company may irrevocably elect to redeem all of the then outstanding principal amount of the Debentures for cash in an amount equal to the entire outstanding principal balance, including accrued and unpaid interest, the Exit Payment and a prepayment premium in an amount equal to 3% of the outstanding principal balance as of the prepayment date (collectively, the “Prepayment Amount”). Upon the entry into a definitive agreement that would effect a change in control (as defined in the Debentures) of the Company, the Agent may require the Company to prepay the outstanding principal balance in an amount equal to the Prepayment Amount. Commencing on March 3, 2024, at its option, the holder of a Debenture may require the Company to redeem 2% of the original principal amount of the Debentures per calendar month which amount may at the Company’s election, subject to certain exceptions, be paid in cash, shares of the Company’s common stock, or a combination thereof.
The JGB Warrants are exercisable for five years from September 3, 2023, at an exercise price of $1.275 per share, a 50% premium to the VWAP on the closing date, subject, with certain exceptions, to adjustments in the event of stock splits, dividends, subsequent dilutive offerings and certain fundamental transactions, as more fully described in the JGB Warrant.
GVB Bridge Loan
On March 3, 2023, the Company executed a Subordinated Promissory Note (the “Subordinated Note”) with a principal amount of $2,864,767 in favor of Omnia Ventures, LP (“Omnia”). The Subordinated Note refinanced the 12% Secured Promissory Note with a principal amount of $1,000,000 dated as of October 29, 2021 payable to Omnia (the “October Note”) and the 12% Secured Promissory Note with a principal amount of $1,500,000 dated as of January 14, 2022 payable to Omnia (the “January Note”, and together with the October Note, the “Original Notes”), which were assumed by the Company in connection with the acquisition of GVB Biopharma.
Under the terms of the Subordinated Note, the Company is obligated to make interest payments in-kind (the “PIK Interest”). The PIK Interest accrues at a rate of 26.5% per annum, payable monthly. The Company is not permitted to prepay all or any portion of the outstanding balance on the Subordinated Note prior to maturity. The maturity date of the Subordinated Note is May 1, 2024.
July 2022 Equity Raise
On July 25, 2022, we completed a capital raise through a registered direct offering and issued 17,073 shares of common stock for net cash proceeds of $32,484. This excludes the proceeds, if any, from the exercise of the 17,073 warrants sold in the private placement that occurred concurrently with this offering.
Impact of Recently Issued Accounting Standards
In the normal course of business, we evaluate all new accounting pronouncements issued by the Financial Accounting Standards Board (“FASB”), SEC, or other authoritative accounting bodies to determine the potential impact they may have on our Consolidated Financial Statements. Refer to Note 1 “Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements contained in Item 8 of this report for additional information about these recently issued accounting standards and their potential impact on our financial condition or results of operations.
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Critical Accounting Estimates
Management’s discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with GAAP. We make estimates and assumptions in the preparation of our consolidated financial statements that affect the reported amounts of assets and liabilities, revenue and expenses and related disclosures of contingent assets and liabilities. We base our estimates and judgments upon historical experience and other factors that are believed to be reasonable under the circumstances. Changes in estimates or assumptions could result in a material adjustment to the consolidated financial statements.
We have identified several critical accounting estimates. An accounting estimate is considered critical if both: (a) the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment involved, and (b) the impact of changes in the estimates and assumptions have had or are reasonably likely to have a material effect on the consolidated financial statements. This listing is not a comprehensive list of all of our accounting policies. For further information regarding the application of these and other accounting policies, see Note 1 “Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements contained in Item 8 of this report.
Inventories
Inventories are measured on a first-in, first-out basis at the lower of cost or net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The valuation of inventory requires us to estimate obsolete or excess inventory, as well as inventory that is not of saleable quality.
Historically, our adjustments or write-off charges recorded against inventory have been adequate to cover our losses. However, variations in methods or assumptions or volatility in spot pricing for hemp/cannabis could have a material impact on our results. Additionally, if our demand forecasts for specific products is greater than actual demand and we fail to reduce manufacturing output accordingly, we could be required to record additional inventory write-down or expense a greater amount of overhead costs, which would negatively impact our gross profit and net income.
Valuation of Long-Lived Assets
We make assumptions in establishing the carrying value, fair value and, if applicable, the estimated lives of our intangible and other long-lived assets. Goodwill and intangible assets determined to have an indefinite useful life are not amortized. Instead, these assets are evaluated for impairment on an annual basis on December 1, the measurement date, and whenever events or business conditions change that could indicate that the asset is impaired. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset (asset group) may not be recoverable.
Evaluation of goodwill for impairment
We test each reporting unit’s goodwill for impairment on the measurement date and between annual tests if an event occurs or circumstances change that would more-likely-than-not reduce the fair value of a reporting unit below its carrying value. In conducting this annual impairment testing, we may first perform a qualitative assessment of whether it is more-likely-than-not that a reporting unit’s fair value is less than its carrying value. A qualitative assessment requires that the Company consider events or circumstances including, but not limited to, macro-economic conditions, market and industry conditions, cost factors, competitive environment, changes in strategy, changes in customers, changes in the Company’s stock price, results of the last impairment test, and the operational stability and the overall financial performance of the reporting units. If not, no further goodwill impairment testing is required. If it is more-likely-than-not that a reporting unit’s fair value is less than its carrying value, or if we elect not to perform a qualitative assessment of a reporting unit, a quantitative analysis is performed, in which the fair value of the reporting unit is compared to its carrying value. To determine the fair values, the Company uses a weighted combination of the market approach based on comparable publicly traded companies and the income approach based on estimated discounted future cash flows. The
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cash flow assumptions consider historical and forecasted revenue, operating costs and other relevant factors. If the carrying value of a reporting unit exceeds its fair value, an impairment loss is recognized equal to the excess, limited to the amount of goodwill allocated to that reporting unit.
We completed our annual goodwill impairment test as of December 1, 2022, and determined, after performing a quantitative assessment of the Hemp/cannabis reporting unit, the fair value of the Hemp/cannabis reporting unit exceeded its carrying amount. Resulting from the quantitative analysis, the fair value exceeded the carrying value of the Hemp/cannabis reporting unit by approximately 25%. We do not believe that any of our reporting units are at risk for impairment. However, changes to the factors considered above could affect the estimated fair value of one or more of our reporting units and could result in a goodwill impairment charge in a future period. We may be unaware of one or more significant factors that, if we had been aware of, would cause our conclusion to change, which could result in a goodwill impairment charge in a future period.
Evaluation of indefinite-lived intangible assets for impairment
Our indefinite-lived intangible assets include the certain trademarks and tradename and licenses. Similar to goodwill, we perform an annual impairment review of our indefinite-lived intangible assets on the last day of our fiscal year, unless events occur that trigger the need for an interim impairment review. We have the option to first assess qualitative factors in determining whether it is more-likely-than-not that an indefinite-lived intangible asset is impaired. If we elect not to use this option, or we determine that it is more-likely-than-not that the asset is impaired, we perform a quantitative assessment that requires us to estimate the fair value of each indefinite-lived intangible asset and compare that amount to its carrying value. Fair value is estimated using the relief-from-royalty method. Significant assumptions inherent in this methodology include estimates of royalty rates and discount rates. The discount rate applied is based on the risk inherent in the respective intangible assets and royalty rates are based on the rates at which comparable tradenames are being licensed in the marketplace. Impairment, if any, is based on the excess of the carrying value over the fair value of these assets.
For our indefinite-lived intangible assets—MSA, cigarette brand predicate and trademarks—we performed a qualitative evaluation and considered factors such as current and future sales projections, strategic objectives, future market and economic conditions, competition, and federal and state regulations. We determined it is more likely than not that that the assets are not impaired.
For our indefinite-lived intangible asset relate to the GVB tradename, we performed a quantitative assessment to test the asset for impairment as of December 1, 2022. The fair value was determined by utilizing the relief from royalty method with valuation assumptions consisting of royalty rate of 1.0% and discount rate of 24.5%. The estimated fair value was concluded to be below carrying value and as a result an impairment charge of $1,453 was recorded.
We do not believe that our indefinite-lived intangible assets are at risk for further impairment. However, a significant increase in the discount rate, decrease in the terminal growth rate, increase in tax rates, decrease in the royalty rate or substantial reductions in our revenue assumptions could have a negative impact on the estimated fair value of our tradename and require us to recognize additional impairment in a future period.
Evaluation of long-lived assets for impairment
When impairment indicators exist, we determine if the carrying value of the long-lived asset(s) or definite-lived intangible asset(s) including, but not limited to, PP&E and right-of-use lease assets, exceeds the related undiscounted future cash flows. In cases where the carrying value exceeds the undiscounted future cash flows, the carrying value is written down to fair value. Fair value is generally determined using a discounted cash flow analysis. When it is determined that the useful life of an asset (asset group) is shorter than the originally estimated life, and there are sufficient cash flows to support the carrying value of the asset (asset group), we accelerate the rate of depreciation/amortization in order to fully depreciate/amortize the asset over its shorter useful life.
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Estimation of the cash flows and useful lives of long-lived assets and definite-lived intangible assets requires significant management judgment. Events could occur that would materially affect our estimates and assumptions. Unforeseen changes, such as the loss of one or more significant customers, technology obsolescence, or significant manufacturing disruption, among other factors, could substantially alter the assumptions regarding the ability to realize the return of our investment in long-lived assets, definite-lived intangible assets or their estimated useful lives.
Business Combinations
The Company accounts for business combinations in accordance with ASC Topic 805, Business Combinations . The fair value of the consideration paid is assigned to the underlying net assets of the acquired business based on the respective fair values of identifiable assets acquired and liabilities assumed on the date of acquisition. Any excess purchase price over the fair value of net assets acquired is recorded to goodwill. Determining the fair value of these items requires management’s judgment and often also requires the use of independent valuation specialists. Fair value determinations and useful life estimates are based on, among other factors, estimates of expected future cash flows from revenues of the intangible assets acquired, estimates of appropriate discount rates used to present value expected future cash flows, estimated useful lives of the intangible assets acquired and other factors. The judgments made in the determination of the estimated fair values assigned to the assets acquired and the liabilities assumed, as well as the estimated useful life of certain assets and liabilities, can materially impact the financial statements in periods after acquisition, such as through depreciation and amortization expense. For more information see Note 2 “Business Combinations” of the Notes to Consolidated Financial Statements.
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.
Off-Balance Sheet Arrangement
We do not have any off-balance sheet arrangements as defined by Item 303(a)(4) of Regulation S-K.
Item 7A. Quantitative and Qu alitative Disclosures About Market Risk
Not required for smaller reporting companies.