2014 ANNUAL REPORT
2014 ANNUAL REPORT
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22nd Century Group, Inc.
9530 Main Street
Clarence, New York 14031
Telephone: (716) 270-1523
Fax: (716) 877-3064
xxiicentury.com
© 22nd Century Group, Inc.
Innovative Cigarettes
for those who enjoy smoking
Groundbreaking Smoking Cessation
Product in Development
for those who wish to quit
The material in this presentation is provided for the purpose of giving information about
22nd Century Group to investors and is not provided for tobacco product advertising,
promotional, or marketing purposes. This material does not constitute and should not
be construed as constituting an offer to sell, or a solicitation of an offer to buy, any of
our tobacco products.
2014 Annual Report Cover.indd 1
3/5/15 6:08 PM
22nd Century Group, Inc.
Dear Fellow Shareholders:
As expected, 2014 represented a
period of transition for 22nd Century
Group. From our inception, the
Company focused primarily on
research and development. Since
the latter part of last year, however,
we recast our priorities to instead
concentrate our efforts on monetizing
our exceptional intellectual property
portfolio.
Coinciding with this change, in March 2015, our Board of
Directors appointed me Chief Executive Officer. I am honored
and tremendously excited to have been chosen to lead the
Company at this momentous time in our history.
Our technology is extraordinary. Our management team is
exceptional. Our mission is noteworthy. Indeed, in my new
position, I have reemphasized our core mission: to reduce
the harm caused by smoking. In pursuit of this important
goal, we intend to help millions of consumers who will use our
products… and, at the same time, provide substantial value to our
shareholders.
22nd Century is in the rare position of having a virtual monopoly
around the nicotine biosynthetic pathway in the tobacco plant.
To capitalize on this extraordinary asset we have articulated the
Company’s most important priorities as follows:
1) Pursuit of FDA authorization for our BRAND A modified
risk cigarettes in development;
2) Contracting with a suitable joint venture partner to
fund and conduct a Phase III clinical trial for X-22, the
Company’s tobacco-based smoking cessation aid in
development;
3) Obtaining substantial, multi-year sales contracts in Asia
for our proprietary tobacco products;
4) Commercialization of RED SUN® super-premium
cigarettes in the U.S.;
5) Launching MAGIC® very low nicotine cigarettes in Europe,
starting with Spain in the latter part of March 2015; and
6) Establishing a base of third-party contract manufacturing
business at our NASCO manufacturing facility.
The Company’s very low nicotine BRAND A modified risk
candidate is exactly consistent with what public health officials
have long sought:
“The FDA should quickly move to reduce nicotine levels in cigarettes
to non-addictive level. If we reduce the level of the stimulus, we
reduce the craving. It is the ultimate harm reduction strategy.”
Dr. David Kessler, Former FDA Commissioner
June 16, 2010
There could be no stronger endorsement – from a more influential
public health official – than Dr. Kessler’s definition of “the
ultimate harm reduction strategy.” As the only company in
the world capable of producing tobacco cigarettes – without
extraction – with 95% less nicotine than conventional cigarettes,
22nd Century is in the unique position of being able to achieve
precisely what Dr. Kessler envisions. To this end, we look forward
to submitting our application to the FDA later this year for our very
low nicotine BRAND A modified risk cigarettes in development.
Also utilizing our proprietary very low nicotine (VLN) tobacco,
our X-22 smoking cessation aid in development is another
strategic imperative for the Company. We hope to announce a
joint venture partner later this year to fund our Phase III clinical
trial and to help us commercialize X-22. There is good reason
for us to be enthusiastic about X-22: There have been five
independent Phase II clinical trials – and one independent Phase
III clinical trial – that have utilized cigarettes made from 22nd
Century’s proprietary tobacco (treating 2,438 total smokers);
in all 6 independent trials, VLN cigarettes increased quit rates.
Indeed, our VLN cigarettes are in a unique position in that there
is evidence in clinical studies demonstrating: (i) VLN cigarettes
work by themselves, (ii) VLN cigarettes increase the efficacy
of nicotine replacement therapy products (patch, gums and
lozenges), and (iii) VLN cigarettes increase the efficacy of Pfizer’s
Chantix®. The smoking cessation market is a multi-billion dollar
industry and securing even a small portion of that market would
be quite significant for our Company. To this end, the approval of
X-22 by the FDA would be monumental for our Company and our
shareholders.
We also intend to continue to pursue potential joint ventures
and other business opportunities in Asia. To further facilitate
22nd Century’s business opportunities in Asia, I will be making
additional trips to Asia in 2015. I am optimistic that we will be able
to announce one or more business contracts with Asian partners
in 2015.
An important step along 22nd Century’s path to commercialization
occurred when our Company became a subsequent participating
member of the U.S. tobacco Master Settlement Agreement
(MSA). Through our acquisition of NASCO Products, LLC, we
were the first company in more than six years to become a
new signatory to the MSA. As a result of this very important
achievement, the Company began the process of listing its super-
premium brand, RED SUN,® on the state tobacco directories of
approved products across the United States. We have received
approvals from 42 states already and we expect to gain approval
from the remaining states very soon.
Our Company also continues to move forward with efforts to
launch our MAGIC® brand of very low nicotine cigarettes in
Europe and Asia. Our Company’s contract cigarette manufacturer
in Europe has begun production of our MAGIC® brand for a
product launch in Spain planned for the latter part of March 2015.
We have already received preorders from several hundred stores
in Spain, the MAGIC® website is nearly complete, and we are
increasingly excited about the prospects of MAGIC® in Spain and
in other parts of Europe.
Looking ahead, our prospects have never been better. We are
intensely focused on the business drivers which will make the
biggest differences for our Company and our shareholders. On
behalf of the 22nd Century Group management team, we thank
you for being part of our family of shareholders; we look forward
to keeping you apprised of our exciting commercialization
achievements in the months to come.
Best regards,
Henry Sicignano III
Chief Executive Officer, President
& Director
CORPORATE HEADQUARTERS
EXECUTIVE OFFICERS
Annual Meeting Notice
22nd Century Group, Inc.
9530 Main Street
Henry Sicignano III
President & CEO
Clarence, NY 14031
(716) 270-1523
xxiicentury.com
Investor Relations
Redington, Inc.
49 Richmondville Ave.
Westport, CT 06880
Phone: 203-222-7399
Fax: 203-222-1819
Legal Counsel
Foley & Lardner LLP
3000 K Street, NW
6th Floor
Washington, DC 20007
Phone: 202-672-5300
Fax: 202-672-5399
Auditors
Freed Maxick CPA’s, PC
Liberty Building, Suite 800
424 Main Street
Buffalo, NY 14202-3508
Phone: 716-847-2651
Fax: 716-847-0069
Transfer Agent
Continental Stock and
Transfer Company
17 Battery Place
New York, NY 10004
Phone: 212-509-4000
Fax: 212-509-5150
The Annual Meeting
of Shareholders:
Saturday, April 25, 2015
2:00 p.m.
The Buffalo Club
388 Delaware Avenue
Buffalo, NY 14202
John T. Brodfuehrer
Chief Financial Officer
Thomas L. James, Esq.
Vice President, General Counsel
& Secretary
Stockholder Information
Michael Moynihan, Ph.D.
Vice President of R&D
DIRECTORS
Henry Sicignano III
President & CEO
Requests for interim reports
(Form 10-Q) and annual reports
(Form 10-K) and requests for
more information about the
Company should be directed
in writing to:
Joseph Alexander Dunn, Ph.D.
Associate Dean for Research
22nd Century Group, Inc.
Attn: Chief Financial Officer
9530 Main Street
and Professor of Pharmaceutical
Clarence, NY 14031
Press releases and Securities and
Exchange Commission filings are
available by visiting our website at
www.xxiicentury.com
Sciences, D’Youville College
of Pharmacy
James W. Cornell
President and CEO
Praxiis, LLC
Richard M. Sanders
Partner
Phase One Ventures, LLC
Joseph Pandolfino
Founder
2014 Annual Report Cover.indd 2
3/5/15 6:08 PM
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report under Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the fiscal year ended December 31, 2014
or
Transitional Report under Section 13 or 15(d) of the
Securities Exchange Act of 1934
Commission File Number: 001-36338
22nd Century Group, Inc.
(Exact name of registrant as specified in its charter)
Nevada
(State or other jurisdiction
of incorporation)
98-0468420
(IRS Employer
Identification No.)
9530 Main Street, Clarence, New York 14031
(Address of principal executive offices)
(716) 270-1523
Registrant’s telephone number, including area code
Securities registered under Section 12(b) of the Act: None
Securities registered under Section 12(g) of the Act:
Common Stock (Par Value - $0.00001 per share)
Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act
Yes No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act.
Yes No
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required
to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was
required to submit and post such files)
Yes No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.
Large Accelerated Filer
Accelerated Filer
Non-Accelerated Filer
Smaller Reporting Company
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Act).Yes No
As of June 30, 2014, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate value of the registrant’s common
stock (excluding the 16,135,155 shares held by affiliates), based upon the $3.07 price at which such common stock was last sold on June 30, 2014, was
approximately $133.4 million.
As of February 4, 2015, there were 64,335,042 shares of common stock issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Proxy Statement for its 2015 Annual Meeting of Stockholders are incorporated herein by reference in Part III of this
Annual Report on Form 10-K. Such Proxy Statement will be filed with the Securities and Exchange Commission within 120 days of December 31, 2014.
22nd Century Group, Inc.
Table of Contents
PART I
BUSINESS.
RISK FACTORS.
UNRESOLVED STAFF COMMENTS.
PROPERTIES.
LEGAL PROCEEDINGS.
MINE SAFETY DISCLOSURES
PART II
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES.
SELECTED FINANCIAL DATA.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
CONTROLS AND PROCEDURES.
OTHER INFORMATION.
PART III
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
EXECUTIVE COMPENSATION.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
MATTERS.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
PRINCIPAL ACCOUNTING FEES AND SERVICES
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
PART IV
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ITEM 1.
ITEM 1A.
ITEM 1B.
ITEM 2.
ITEM 3.
ITEM 4.
ITEM 5.
ITEM 6.
ITEM 7.
ITEM 7A.
ITEM 8.
ITEM 9.
ITEM 9A.
ITEM 9B.
ITEM 10.
ITEM 11.
ITEM 12.
ITEM 13.
ITEM 14.
ITEM 15.
2
Cautionary Note Regarding Forward-Looking Statements
This Annual Report on Form 10-K contains forward-looking statements concerning our business, operations and financial
performance and condition as well as our plans, objectives and expectations for our business operations and financial performance and
condition that are subject to risks and uncertainties. All statements other than statements of historical fact included in this Annual Report
on Form 10-K are forward-looking statements. You can identify these statements by words such as “aim,” “anticipate,” “assume,”
“believe,” “could,” “due,” “estimate,” “expect,” “goal,” “intend,” “may,” “objective,” “plan,” “potential,” “positioned,” “predict,”
“should,” “target,” “will,” “would” and other similar expressions that are predictions of or indicate future events and future trends. These
forward-looking statements are based on current expectations, estimates, forecasts and projections about our business and the industry in
which we operate and our management's beliefs and assumptions. These statements are not guarantees of future performance or
development and involve known and unknown risks, uncertainties and other factors that are in some cases beyond our control. All
forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those that we
expected, including:
• Our ability to manage our growth effectively;
• Our ability to comply with existing and new government regulations;
• Our ability to retain key personnel;
• Our ability to enter into additional licensing transactions;
• Our ability to achieve profitability and positive cash flows;
• The potential for our clinical trials to produce negative or inconclusive results;
• Our ability to obtain significant revenue for our tobacco products in the U.S.;
• Our ability to obtain U.S. Food and Drug Administration (“FDA”) clearance for our potentially modified risk tobacco products and
FDA approval for our X-22 smoking cessation aid;
• Our ability to gain market acceptance for our products;
• Our ability to raise additional capital;
• Any potential negative impact from entering the cannabis space;
• Our ability to comply with government regulations;
• Our ability to compete with competitors that may have greater resources than we have;
• The potential for our competitors to develop products that are less expensive, safer or more effective than ours;
• The potential exposure to product liability claims, product recalls and other claims; and
• Our ability to adequately protect our intellectual property and to avoid infringement on rights of third parties.
For the discussion of these risks and uncertainties and others that could cause actual results to differ materially from those
contained in our forward-looking statements, please refer to “Risk Factors” in this Annual Report on Form 10-K. The forward-looking
statements included in this Annual Report on Form 10-K are made only as of the date hereof. We undertake no obligation to publicly
update or revise any forward-looking statement as a result of new information, future events or otherwise, except as otherwise required by
law.
Unless the context otherwise requires, references to the “Company” “we” “us” and “our” refer to 22nd Century Group, Inc., a
Nevada corporation, and its direct and indirect subsidiaries.
3
Item 1.
Business.
Background
PART I
22nd Century Group, Inc. was incorporated under the laws of the State of Nevada on September 12, 2005 under the name
Touchstone Mining Limited. On January 25, 2011, we entered into a reverse merger transaction with 22nd Century Limited, LLC, which
we refer to herein as the merger. Upon the closing of the merger, 22nd Century Limited, LLC became our wholly-owned subsidiary. After
the merger, we succeeded to the business of 22nd Century Limited, LLC as our sole line of business.
22nd Century Limited, LLC was originally formed as a New York limited liability company on February 20, 1998 as 21st
Century Limited, LLC and subsequently merged with a newly-formed Delaware limited liability company, 22nd Century Limited, LLC,
on November 29, 1999. Since inception, 22nd Century Limited, LLC has used biotechnology to regulate the nicotine content in tobacco
plants.
Overview
We are a plant biotechnology company specializing in technology that allows for the level of nicotine and other nicotinic
alkaloids (e.g., nornicotine, anatabine and anabasine) in tobacco plants to be decreased or increased through genetic engineering and plant
breeding. We are focused on tobacco harm reduction and smoking cessation products produced from modifying the nicotine content in
tobacco plants through genetic engineering and plant breeding. We own or exclusively control 128 issued patents plus an additional 52
pending patent applications. The patents owned by or exclusively licensed to us include patents issued in 96 countries.
We are in the process of transitioning from researching and developing our proprietary technology and tobaccos to
commercializing our technology and products. Our long-term focus is on licensing, manufacturing and selling of our tobacco products to
reduce the harm caused by smoking. Annual worldwide tobacco product sales, including cigarettes and smokeless products, are
approximately $800 billion, most of which are cigarette sales, according to Euromonitor International.
4
We are primarily involved in the following activities:
• The international licensing of our technology, proprietary tobaccos, and trademarks;
• The international sale of our branded proprietary tobaccos;
• The manufacture, marketing and distribution of RED SUN and MAGIC proprietary cigarettes;
• The production of SPECTRUM research cigarettes for the National Institute on Drug Abuse (“NIDA”), a part of the National
Institutes of Health (“NIH”);
• The research and development of potentially less harmful or modified risk tobacco products and novel tobacco plant varieties;
• The development of X-22, a prescription-based smoking cessation aid consisting of very low nicotine (“VLN”) cigarettes;
• The pursuit of necessary regulatory approvals and clearances from the FDA to market in the U.S X-22 as a prescription smoking
cessation aid and BRAND A and BRAND B as reduced-risk or modified risk cigarettes;
• The contract manufacturing of third-party branded tobacco products; and
• The research and development in Canada of unique plant varieties of hemp/cannabis, such as (i) plants with low to no amounts of
delta-9-tetrahydrocannabinol, or THC, for the legal hemp industry, (ii) plants with high levels of THC for the legal recreational
cannabis markets, and (iii) plants with high levels of cannabidiol, or CBD, and other non-THC cannabinoids for the legal medical
marijuana markets.
Our prospects depend on our ability to generate and sustain revenues from (i) the international licensing and/or sale of our
proprietary tobacco, technology and products; (ii) the domestic and international sales of our brands, including RED SUN and MAGIC;
(iii) the further development of our potential modified risk tobacco products and our X-22 smoking cessation aid; and (iv) the manufacture
of the filtered cigar and cigarette brands of third-parties at our manufacturing facility in North Carolina. Our ability to generate
meaningful revenue from our potential modified risk tobacco products in the United States depends on obtaining FDA authorization to
market these products as modified risk; and our ability to generate meaningful revenue in the United States from X-22 depends on FDA
approval. If these products are authorized and approved by the FDA, we must still meet the challenges of successful marketing,
distribution and consumer acceptance.
We believe our proprietary technology, tobaccos and products can generate multiple significant revenue streams from licensing
of our technology and tobacco and from the sales of our products.
We also believe that our products address unmet needs of smokers; for those who desire to quit, an innovative smoking cessation
aid, and for those who are unable or unwilling to quit smoking, cigarettes that may reduce the level of exposure to tobacco toxins.
5
Intellectual Property
Our proprietary technology enables us to decrease or increase the level of nicotine (and other nicotinic alkaloids such as
nornicotine, anatabine and anabasine) in tobacco plants by decreasing or increasing the expression of gene(s) responsible for nicotine
production in the tobacco plant using genetic engineering. The basic techniques include, but are not limited to, those that are used in the
production of genetically modified (“GM”) varieties of other crops, which are also known as “biotech crops.”
We own or exclusively control 128 issued patents plus an additional 52 pending patent applications, The patents owned by us or
exclusively licensed to us include patents issued in 96 countries. The patents and patent applications that we own include the intellectual
property that we acquired from the National Research Council of Canada (“NRC”) on December 23, 2014 that was previously licensed to
us by NRC on an exclusive basis. A “patent family” is a set of patents granted in various countries to protect a single invention. Our
patent coverage in the United States and China, two of the most valuable smoking cessation and cigarette markets in the world, consists of
19 issued patents and 19 pending applications and 6 issued patents and 4 pending patent applications, respectively. We have exclusive
rights to all uses of the following genes responsible for nicotine content in tobacco plants: NBB, QPT, A622, MPO and several
transcription factor genes. We have exclusive rights to plants with altered nicotine content produced from modifying expression of these
genes and tobacco products produced from these plants. We also have the exclusive right to license and sublicense these patent rights.
In September 2014, we entered into a Sublicense Agreement with Anandia Laboratories, Inc. (the “Anandia Sublicense”). Under
the terms of the Anandia Sublicense, we were granted an exclusive sublicense in the United States and a co-exclusive sublicense in the
remainder of the world, excluding Canada, to 1 U.S. patent and 20 patent applications relating to four genes in the cannabis plant that are
required for the production of cannabinoids, the active ingredients in the cannabis plant. The Anandia Sublicense continues through the
life of the last-to-expire patent, which is expected to be in 2035. As a plant biotechnology company, our entry into the legal
hemp/cannabis markets is a natural evolution of our activities in a plant that has important research and commercial value and
applications. We intend to engage in research and development activities in Canada to create unique plant varieties of hemp/cannabis,
such as (i) plants with low to no amounts of THC for the legal hemp industry, (ii) plants with high levels of THC for the legal
recreational cannabis markets, and (iii) plants with high levels of CBD and other non-THC cannabinoids for the legal medical marijuana
markets.
We own various registered trademarks in the United States. We also have exclusive plant variety rights in the United States
(plant variety protection certificates are issued by the U.S. Department of Agriculture) and Canada. A PVP certificate prevents anyone
other than the owner/licensee from planting, propagating, selling, importing and exporting a plant variety for twenty (20) years in the U.S.
and generally for twenty (20) years in other member countries of the International Union for the Protection of New Varieties of Plants,
known as UPOV, an international treaty concerning plant breeders’ rights. There are currently more than 70 countries that are members of
UPOV.
6
Licensing our technology and tobacco
We have been in negotiations with various parties in the tobacco and pharmaceutical industries for licensing our technology and
products. On October 1, 2013, our subsidiary, 22nd Century Limited, LLC (“22nd Century Ltd.”), entered into a Research License and
Commercial Option Agreement (the “BAT Research Agreement”) with British American Tobacco (Investments) Limited (“BAT”), a
subsidiary of British American Tobacco plc.
Under the terms of the BAT Research Agreement, BAT receives an exclusive worldwide license to certain patent rights (subject
to worldwide rights retained by 22nd Century Ltd. for use in its own brands and products) and licensed intellectual property rights (as
such terms are defined in the BAT Research Agreement) of 22nd Century Ltd. within the field of use (as defined in the BAT Research
Agreement) for a period of up to four (4) years (the “Research Term”). During the Research Term, BAT also has an option, which can be
exercised by BAT at any time during the Research Term, to obtain an exclusive worldwide license (subject to worldwide rights retained
by 22nd Century Ltd. for use in its own products and brands) to commercialize certain products derived from utilizing the patent rights
and licensed intellectual property rights under the terms of a commercial license agreement (the “Commercial License”).
Simultaneous with the signing of the BAT Research Agreement, BAT paid 22nd Century Ltd. a non-refundable fee of $7.0
million. Further, 22nd Century Ltd. may receive payments from BAT of up to an additional $7.0 million during the Research Term in the
event certain milestones are met by BAT with respect to its research and development of the patent rights and licensed intellectual
property rights licensed by 22nd Century Ltd. to BAT. There are four separate milestones, two of which BAT would pay 22nd Century
Ltd. $2.0 million for each milestone achieved, and two of which BAT would pay 22nd Century Ltd. $1.5 million for each milestone
achieved. BAT may terminate the BAT Research Agreement at any time, subject to the requirements for certain payments to 22nd
Century Ltd. by BAT upon termination as set forth therein. 22nd Century Ltd. may also terminate the BAT Research Agreement in the
event of certain uncured breaches of the BAT Research Agreement as set forth therein.
BAT also granted to 22nd Century Ltd. a worldwide license to any and all registered research results (as such term is defined in
the BAT Research Agreement) developed and owned by BAT which results or arises from any research, development or other activities
of BAT under the BAT Research Agreement, with the terms of such license from BAT to 22nd Century Ltd. (i) to be on commercially
reasonable terms to be negotiated in good faith between the parties, but in any event on terms which are no more onerous than the terms
of the Commercial License, if any, and (ii) to be dependent on what, if any, research results the Company elects to license.
If BAT exercises the option for a worldwide Commercial License, BAT is required to pay 22nd Century Ltd. $3.0 million in
aggregate annual license fees over a 2-year ramp-up period, and thereafter, a royalty of (i) $100 per metric ton of licensed tobacco that is
supplied to, or grown and ready for shipment to, BAT and its affiliates (other than Reynolds American, Inc. and Reynolds’ affiliates) and
all other third parties; and (ii) $200 per metric ton of licensed tobacco supplied to, or grown and processed by, BAT’s affiliate Reynolds
American, Inc.
The minimum and maximum amount of annual royalties under the terms of the Commercial License, which commence after the
two-year ramp-up period from the exercise of the commercial option, are $3.0 million and $15.0 million, respectively, for a period of
three years. Thereafter, the minimum and maximum annual royalties increase to $5.0 million and $25 million, respectively, until
September 28, 2028. Thereafter, no further minimum royalties are due and the maximum annual royalties due remain at $25 million until
expiration of the Commercial License.
Beginning three years from the start of the Commercial License, both 22nd Century Ltd. and BAT may license/sublicense rights
to any unaffiliated third party for use of the technology outside the United States and 22nd Century Ltd. and BAT will equally share all
profit from all such licensees/sublicensees. Inside the United States, BAT may only sublicense BAT’s commercial rights to Reynolds
American Inc. 22nd Century Ltd. may sublicense any party in the United States.
7
RED SUN and MAGIC Cigarettes
Our subsidiary, Goodrich Tobacco Company, LLC (“Goodrich Tobacco”), introduced in a limited capacity two super-premium priced cigarette
brands, RED SUN and MAGIC, into the U.S. market in the first quarter 2011. There have been de minimis sales of these brands since we intentionally did
not expand the marketing and distribution of these brands until after the Company became a subsequent participating manufacturer under the MSA, which
occurred on August 29, 2014, when the 46 Settling States under the MSA approved the Company to acquire NASCO Products, LLC (“NASCO”) and
become a subsequent participating manufacturer under the MSA, as explained in greater detail below under “MSA Membership.” Both of the RED SUN
and MAGIC brands are available in regular and menthol and all brand styles are king size and packaged in hinge-lid hard packs. In 2015, we intend to
focus marketing efforts for RED SUN on national and regional distributors, tobacconists, smokeshops and other tobacco outlets in the U.S. The ban in
2009 by the FDA of all cigarettes with characterizing flavors (with the exception of menthol) has resulted in a product void in these specialty tobacco
channels for super-premium priced products. We believe that certain U.S. cigarette wholesalers and retailers will carry our brands, among other reasons, to
increase their margins.
MSA Membership
In September 2013, the Company entered into a Membership Interest Purchase Agreement (the “Purchase Agreement”) to purchase all of the
issued and outstanding membership interests of NASCO, a federally licensed tobacco product manufacturer and subsequent participating manufacturer
under the MSA (the “NASCO Acquisition”). The initial purchase price for the transaction was $1,000,000 (the “Purchase Price”), subject to potential
closing date adjustments for any unpaid liabilities of NASCO. The Purchase Price was to be paid as follows: (i) a cash payment of $200,000 and (ii) the
issuance of $800,000 in value of unregistered shares of common stock of the Company. The Purchase Agreement was subject to various conditions,
including required consents and authorizations from the National Association of Attorneys General (“NAAG”) and the 46 Settling States under the MSA.
On May 13, 2014, the Company and NASCO executed the First Amendment to the Purchase Agreement (the “Amendment”). The Amendment
increased the Purchase Price of the NASCO Acquisition to $1,050,000 and increased the cash payment to $250,000. In addition, the amendment
eliminated the Company’s closing requirement to enter into a management agreement and sales representation agreement with an affiliate of NASCO.
On August 29, 2014, the Company entered into an Amended Adherence Agreement with the 46 Settling States under the MSA pursuant to which
the Company was approved to acquire NASCO and become a subsequent participating manufacturer under the MSA. On that same date, the Company
closed the NASCO Acquisition and became a subsequent participating manufacturer under the MSA. NASCO is now a wholly-owned subsidiary of the
Company.
Manufacturing
In December 2013, Goodrich Tobacco purchased certain (i) cigarette manufacturing equipment, and (ii) equipment parts, factory items, office
furniture and fixtures, vehicles and computers from the bankruptcy estate of PTM Technologies, Inc. (“PTM”) for $3.22 million. In January 2014,
Goodrich Tobacco purchased additional miscellaneous equipment, factory items, office furniture and fixtures, vehicles and computers from the bankruptcy
estate of Renegade Tobacco Co. (“Renegade”) for $210,000. PTM and Renegade were related companies located in North Carolina undergoing Chapter 7
liquidation proceedings in the United States Bankruptcy Court for the Middle District of North Carolina. Goodrich Tobacco subsequently received
$631,484 in net proceeds from auctioning off certain cigarette manufacturing equipment and other items not required for operations at the Company’s
factory in Mocksville, North Carolina.
The warehouse and cigarette manufacturing facility were primarily in a pre-manufacturing stage during 2014 as we sought approval during that
time for the Company and its factory to become a subsequent participating manufacturer under the MSA. During 2014, we incurred various expenses to
prepare the facility for production. Expenses incurred during the year ended December 31, 2014 amounted to $1,168,876 and consisted primarily of
expenses for salaries and benefits for employees, sub-contract labor, rent, utilities and other miscellaneous costs. We did manufacture a quantity of filtered
cigars during 2014 resulting in revenue of $81,456. On August 29, 2014, the Company closed its acquisition of NASCO and became a subsequent
participating manufacturer under the MSA. The Company is now manufacturing its cigarette brands in the United States through its wholly-owned
subsidiary, NASCO, at the Company’s factory in North Carolina.
Now that we have become a licensed tobacco products manufacturer and a subsequent participating manufacturer under the MSA, we believe that
our ability to produce RED SUN and MAGIC at our factory in North Carolina has increased our distribution potential for our cigarette brands in the U.S.
International Sales
During 2014, Goodrich Tobacco signed a letter of intent with Orion, a cigarette manufacturer in Poland, to contract manufacture the Company’s
proprietary tobacco products for distribution in the European Union. In December 2014, the Company and Orion set out to finalize a manufacturing
agreement to be entered into by the parties. Distribution of MAGIC brand cigarettes is expected to commence in Spain in the first quarter of 2015. Orion is
a manufacturer and distributor of smoking tobaccos, cigarettes, filter tubes, and smoking accessories with distribution in more than 20 countries. In
December 2014, the Company also finalized a new distribution agreement with a European partner to be entered into by the parties in January 2015 for the
launch of sales of the Company’s products in The Netherlands, Belgium and Luxemburg in 2015. The Company is also evaluating the sale and distribution
of its products in other European countries and in Asia, including China.
8
The Tobacco Control Act and Our Potentially Modified Risk Cigarettes – BRAND A and BRAND B
In a 2005 analyst report, The Third Innovation, Potentially Reduced Exposure Cigarettes, JP Morgan examined the effects of regulation by the U.S. Food and Drug
Administration (“FDA”) of tobacco, including the market for safer cigarettes. JP Morgan’s proprietary survey of over 600 smokers found that 90% of smokers are willing to try
a safer cigarette. Among JP Morgan’s other conclusions, it stated: “FDA oversight would imbue PREPS [‘potential reduced exposure products’ which essentially equate to
potential modified risk tobacco products] with a regulatory ‘stamp of approval’ and allow for more explicit comparative health claims with conventional cigarettes. Consumers
should trust the FDA more than industry health claims.” Prior to the Family Smoking Prevention and Tobacco Control Act (“Tobacco Control Act”) becoming law in 2009, no
regulatory agency or body had the authority to assess potential modified risk tobacco products.
The Tobacco Control Act granted the FDA authority over the regulation of all tobacco products. While the Act prohibits the FDA from banning cigarettes outright, it
allows the FDA to require the reduction of nicotine or any other compound in tobacco and cigarette smoke. The Tobacco Control Act also banned all sales in the U.S. of
cigarettes with characterizing flavors (other than menthol). As of June 2010, all cigarette companies were required to cease the use of the terms “low tar,” “light” and “ultra
light” in describing cigarettes sold in the U.S. Besides numerous other regulations, including certain marketing restrictions, for the first time in history, a U.S. regulatory agency
will scientifically evaluate cigarettes that may pose lower health risks as compared to conventional cigarettes.
The Tobacco Control Act establishes procedures for the FDA to regulate the labeling and marketing of modified risk tobacco products, which includes cigarettes that
(i) reduce exposure to tobacco toxins and (ii) are reasonably likely to pose lower health risks, as compared to conventional cigarettes (“Modified Risk Cigarettes”). The
Tobacco Control Act requires the FDA to issue specific regulations and guidance regarding applications submitted to the FDA for the authorization to label and market
Modified Risk Cigarettes. On March 30, 2012, the FDA issued Modified Risk Tobacco Product Applications Draft Guidance. We believe that two types of our cigarettes in
development, which we refer to as BRAND A and BRAND B, may qualify as Modified Risk Cigarettes. In addition, the Tobacco Control Act allows the FDA to mandate the use
of reduced risk technologies in conventional tobacco products and cigarettes (e.g., Marlboro ®), which could create opportunities for us to license our proprietary technology
and/or our tobaccos to larger competitors.
We intend to seek FDA authorization to market BRAND A and BRAND B as Modified Risk Cigarettes. The Company has continued to gather additional information
since the FDA’s draft guidance on the subject, including from the FDA, to submit complete applications for our two Modified Risk Cigarette candidates. Depending on how
many exposure studies and other information the FDA will require, it is likely that we will require additional capital to complete the entire FDA authorization process for our
Modified Risk Cigarettes. The amount of capital is currently unknown since it is uncertain how many exposure studies the FDA will require for BRAND A and BRAND B. We
believe that our BRAND A and BRAND B cigarettes will benefit smokers who are unable or unwilling to quit smoking and who may be interested in cigarettes which reduce
exposure to certain tobacco smoke toxins and/or pose a lower health risk than conventional cigarettes. This includes approximately one-half of the 42 million adult smokers in
the United States who do not attempt to quit in a given year. Compared to commercial cigarettes, the tobacco in BRAND A has approximately 95% less nicotine than tobacco in
cigarettes previously marketed as “light” cigarettes and BRAND B’s smoke contains an extraordinary low amount of “tar” per milligram of nicotine. We believe that BRAND
A and BRAND B will achieve market share in the global cigarette market among smokers who will not quit but are interested in reducing the harmful effects of smoking. We
believe this new regulatory environment represents a paradigm shift for the tobacco industry. There is no guarantee, however, that we will (i) have sufficient capital to complete
the FDA authorization process for our potential Modified Risk Cigarettes, (ii) obtain FDA authorization to market BRAND A or BRAND B as Modified Risk Cigarettes, or (iii)
achieve significant share of the market even with FDA authorization to market our products as Modified Risk Cigarettes.
BRAND A Cigarettes
Compared to commercial tobacco cigarettes, BRAND A has the lowest nicotine content. The tobacco in BRAND A contains approximately 95% less nicotine than
tobacco in leading “light” cigarette brands. Clinical studies have demonstrated that smokers who smoke very low nicotine (“VLN”) cigarettes containing our proprietary
tobacco smoke fewer cigarettes per day resulting in significant reductions in smoke exposure, including “tar,” nicotine and carbon monoxide. Due to the very low nicotine
levels, compensatory smoking does not occur with VLN cigarettes containing our proprietary tobacco (Hatsukami et al. 2010).
In a June 16, 2010 press release, Dr. David Kessler, the former FDA Commissioner, recommended that “[t]he FDA should quickly move to reduce nicotine levels in
cigarettes to non-addictive levels. If we reduce the level of the stimulus, we reduce the craving. It is the ultimate harm reduction strategy.” Shortly thereafter in a Washington
Post newspaper article, Dr. Kessler said that the amount of nicotine in a cigarette should drop from about 10 milligrams to less than 1 milligram. BRAND A contains
approximately 0.7 milligrams of nicotine per cigarette.
A Phase II smoking cessation clinical trial at the University of Minnesota Masonic Comprehensive Cancer Center (Hatsukami et al. 2010) also measured exposure of
various smoke compounds in smokers from smoking a VLN cigarette containing our proprietary tobacco over a six (6)-week period. Smokers significantly reduced their
smoking as compared to their usual brand of cigarettes. The number of VLN cigarettes smoked per day on average decreased from 19 (the baseline number of cigarettes of
smokers’ usual brand) to 12 by the end of the six (6)-week period, even though participants were instructed to smoke ad libitum (as many cigarettes as desired) during
treatment. Furthermore, besides significant reductions in other biomarkers, carbon monoxide (CO) levels, an indicator of smoke exposure, significantly decreased from 20 parts
per million (baseline) to 15 parts per million. Cotinine, a metabolite and biomarker of nicotine, significantly decreased from 4.2 micrograms/mL (baseline) to 0.2
micrograms/ml. All differences were statistically significant (P<0.05).
A recently completed study led by the University of Pittsburgh directly compared perceptions of and smoking behaviour with SPECTRUM research cigarettes of
different nicotine content produced by us for NIDA in a total of 840 subjects (Clinicial Trials.gov Identifier: NCT01681875). The study included groups of 120 smokers that
received VLN cigarettes with the same nicotine level as used in the initial X-22 Phase IIb study or the nicotine level used in the University of Minnesota and Queen Mary
University trials as discussed below under the heading “X-22 Smoking Cessation Aid.” Results from this study are expected to be available shortly.
Utilizing the results of these and other independent clinical trials, we intend to submit to the Center for Tobacco Products ("CTP") of the FDA an application for
BRAND A as a Modified Risk Cigarette.
We believe these and other results and future exposure studies the FDA may require will result in a modified risk cigarette claim for BRAND A. We further believe
smokers who desire to smoke fewer cigarettes per day while also satisfying cravings and reducing exposure to nicotine will find BRAND A beneficial. There is, however, no
guarantee that BRAND A will be classified as a Modified Risk Cigarette by the FDA.
9
BRAND B Cigarettes
Using a proprietary high nicotine tobacco blend in conjunction with specialty cigarette components, BRAND B allows the smoker to achieve a
satisfactory amount of nicotine per cigarette while inhaling less “tar” and carbon monoxide. At the same time, we do not expect exposure to nicotine from
BRAND B to be significantly higher than some commercially available full flavor cigarette brands. We believe smokers who desire to reduce smoke
exposure but are less concerned about nicotine will find BRAND B beneficial. BRAND B has a “tar” yield between typical “light” and “ultra-light”
cigarettes, but a nicotine yield of typical full flavor cigarettes.
In a 2001 report, entitled Clearing the Smoke, Assessing the Science Base for Tobacco Harm Reduction, the Institute of Medicine notes that a low
“tar”/moderate nicotine cigarette is a viable strategy for reducing the harm caused by smoking. The report states: “Retaining nicotine at pleasurable or
addictive levels while reducing the more toxic components of tobacco is another general strategy for harm reduction.” We believe that evaluation of
BRAND B in short-term human exposure studies will confirm that exposure to smoke, including certain tobacco smoke toxins and carbon monoxide, is
significantly reduced when smoking BRAND B as compared to smoking the leading brands of cigarettes.
Our Company has engaged a major contract research organization (“CRO”) with extensive experience in tobacco exposure studies to assist us in
certain regulatory activities at the CTP related to the Company’s research to support the development of potentially less harmful or modified risk
cigarettes. The Company and the CRO met with the CTP on November 12, 2014 to discuss the development plan and proof of concept study for BRAND
B, a cigarette that produces smoke containing an extraordinarily low amount of “tar” per milligram of nicotine.
We believe results from this and other exposure studies will warrant a modified risk claim for BRAND B. There is, however, no guarantee that
BRAND B will be classified as a Modified Risk Cigarette by the FDA.
X-22 Smoking Cessation Aid
X-22 is a tobacco-based botanical medical product for use as an aid to smoking cessation. The X-22 therapy protocol utilized in our sponsored
Phase IIb clinical trial calls for the patient to smoke our VLN cigarettes over a six-week treatment period to facilitate the goal of the patient quitting
smoking by the end of the treatment period. We believe this therapy protocol has been successful in independent clinical trials because VLN cigarettes
made from our proprietary tobacco satisfy smokers’ cravings for cigarettes while (i) greatly reducing nicotine exposure and nicotine dependence and (ii)
extinguishing the association between the act of smoking and the rapid delivery of nicotine. X-22 involves the same smoking behavior as conventional
cigarettes and because patients are simply switching to VLN cigarettes for 6 weeks, X-22 does not expose the smoker to any new drugs or new side effects.
Annual manufacturer sales of smoking cessation aids in the U.S., all of which must be approved by the FDA, are approximately $1 billion.
Outside the United States, the smoking cessation market is in its infancy and is approximately $3 billion.
Approximately 50% of U.S. smokers attempt to quit smoking each year, but only 2% to 5% actually quit smoking in a given year. It takes
smokers an average of 8 to 11 “quit attempts” before achieving long-term success. Approximately 95% of “self-quitters” (i.e., those who attempt to quit
smoking without any treatment) relapse and resume smoking. The Institute of Medicine, the health arm of the National Academy of Sciences, in a 2007
report concludes: “There is an enormous opportunity to increase population prevalence of smoking cessation by reaching and motivating the 57 percent of
smokers who currently make no quit attempt per year.” We believe that our X-22 smoking cessation aid will be attractive to smokers who have been
frustrated in their previous attempts to quit smoking using other therapies.
Use of existing smoking cessation aids results in relapse rates that can be as high as 90% in the first year after a smoker initially “quits.” Smokers
currently have the following limited choices of FDA-approved products to help them quit smoking:
• varenicline (Chantix® /Champix® outside the U.S.), manufactured by Pfizer, Inc.,
• bupropion (Zyban®), manufactured by GlaxoSmithKline plc, and
• nicotine replacement therapy, or “NRT,” which is available in the U.S. in several forms: gums, patches, nasal sprays, inhalers and
lozenges.
Chantix® and Zyban® are pills and are nicotine free. Chantix®, Zyban® , the nicotine nasal spray and the nicotine inhaler are available by
prescription only in the U.S. Nicotine gums, nicotine patches, and nicotine lozenges are available over-the-counter in the U.S.
Chantix® was introduced in the U.S. market in the fourth quarter 2006. Since 2007, Chantix® has been the best-selling smoking cessation aid in
the United States, with sales, according to Pfizer Inc., of approximately $701 million in 2007, $489 million in 2008, $386 million in 2009, $330 million in
2010, $326 million in 2011, $313 million in 2012 and $343 million in 2013. In July 2009, the FDA required a “Boxed Warning,” the most serious type of
warning in prescription drug labeling, for both Chantix® and Zyban® based on the potential side effects of these drugs. Despite this Boxed Warning,
worldwide sales of Chantix® in 2009 to 2013 were approximately $700 million, $755 million, $720 million, $670 million and $648 million, respectively.
Other than Chantix® and Zyban®, the only FDA-approved smoking cessation therapy in the United States is nicotine replacement therapy
(“NRT”). These products consist of gums, patches, nasal sprays, inhalers and lozenges. Nicotine gums and nicotine patches have been sold in the U.S. for
approximately 30 years and 22 years, respectively, and millions of smokers have already tried NRT products and failed to stop smoking due to the limited
effectiveness of these products. According to Perrigo Company plc, a pharmaceutical company that sells NRT products, retail sales of NRT products in the
United States were approximately $900 million in its fiscal year ended June 30, 2014.
10
Research and Development
Since our inception, the majority of our research and development (“R&D”) efforts have been outsourced to highly qualified
groups in their respective fields. Since 1998, we have had multiple R&D agreements with North Carolina State University (“NCSU”)
resulting in exclusive worldwide licenses to various patented technologies. We have utilized the same model employed by many public-
sector research organizations which entails obtaining an exclusive option or license agreement to any invention arising out of funded
research. In all cases, we fund and control all patent filings as the exclusive licensee. This model of contracting with public-sector
researchers has enabled the Company to control R&D costs while achieving our desired results, including obtaining exclusive intellectual
property rights relating to our outsourced R&D.
Other R&D partners with the same arrangement have included the National Research Council of Canada, Plant Biotechnology
Institute in Saskatoon, Canada (“NRC”), and the Nara Institute of Science and Technology in Nara, Japan (“NAIST”). The majority of
this R&D has involved the biosynthesis of nicotine in plants. Our R&D agreements with NCSU, NRC and NAIST expired in 2009. In
2010, NAIST assigned to us all of their worldwide patents and patent applications that were previously licensed to us on an exclusive
basis. These patents and patent applications were a result of our R&D at NAIST. On December 23, 2014, we purchased from NRC all the
patents and patent applications that were previously licensed to us on an exclusive basis.
In November 2011, we entered into an R&D agreement with the University of Virginia (“UVA”) relating to nicotine
biosynthesis in tobacco plants with a total budget of $500,000 for the period from November 2011 through December 31, 2013. The term
of the R&D agreement with UVA was subsequently extended to May 31, 2016, with a total budget of $972,727. In 2014, we incurred
approximately $223,000 of expenses for the R&D agreement at UVA.
We have committed to an R&D agreement with NCSU relating to nicotine biosynthesis in tobacco plants with a total budget of
approximately $163,000 for the period from February 2014 through January 2016. Upon identifying a suitable joint venture partner or
licensee to fund further X-22 clinical trials, we may also carry out additional X-22 clinical trials.
During the years ended December 31, 2014, 2013 and 2012, we incurred total research and development expenses of
approximately $1,249,007, $744,000 and $729,000, respectively.
Sources of Raw Materials
We obtain a large portion of our tobacco leaf requirements from farmers in multiple U.S. states that are under direct contracts
with us. The contracts prohibit the transfer of our proprietary seedlings and plant materials to other parties. We purchase the balance of
our tobacco requirements through third parties. As we expand our sales and distribution of our current commercial brands and proceed to
market with our X-22 smoking cessation aid and BRAND A and BRAND B cigarettes, we plan to increase the amount of tobacco leaf we
obtain directly from farmers under contract, both in the United States and in foreign countries.
11
Products
RED SUN and MAGIC Cigarettes
Goodrich Tobacco introduced two super-premium priced cigarette brands, RED SUN and MAGIC, into the U.S. market in the first quarter 2011. Both brands are
available in regular and menthol and all brand styles are king size and packaged in hinge-lid hard packs. In 2015, we intend to focus our marketing and sales efforts for RED
SUN on independent retailers, tobacconists, smokeshops and other tobacco outlets in the U.S. The ban in 2009 by the FDA of all cigarettes with characterizing flavors (with the
exception of menthol) has resulted in a product void in these tobacco channels for super-premium priced products. We believe that certain U.S. cigarette wholesalers and
retailers will carry our brands, among other reasons, to increase their margins. To facilitate Goodrich Tobacco becoming a subsequent participating manufacturer under the
MSA, we had previously curtailed the sales and marketing of these products in order to minimize the fines and penalties that we would be required to pay when we were
approved to become a subsequent participating manufacturer under the MSA. When we were approved on August 29, 2014 by the 46 Settling States to become a subsequent
participating manufacturer under the MSA, Goodrich Tobacco was required to pay an aggregate of $17,546 in fines for prior sales of RED SUN and MAGIC in the U.S. market
when those brands were previously produced by a non-participating manufacturer. On a going-forward basis, RED SUN and MAGIC will be produced by our NASCO
subsidiary at our factory in North Carolina, which is now a subsequent participating manufacturer under the MSA.
SPECTRUM Government Research Cigarettes
NIDA, a part of NIH, provides the scientific community with controlled and uncontrolled research chemicals and drug compounds in its Drug Supply Program. NIDA
included an option to develop and produce research cigarettes with various levels of nicotine (from very low to high), or Research Cigarette Option, in its request for proposals
for a five-year contract for Preparation and Distribution of Research and Drug Products. We agreed, as a subcontractor to RTI International (“RTI”) in RTI’s contract with
NIDA for the Research Cigarette Option, to supply modified nicotine (from very low to high) cigarettes to NIDA. In August 2010, we met with officials from NIDA, FDA,
RTI, the National Cancer Institute and the Centers for Disease Control and Prevention to finalize certain aspects of the design of these research cigarettes. These government
research cigarettes produced by us under the mark SPECTRUM were distributed by NIDA to researchers free of charge. Goodrich Tobacco has thus far delivered approximately
17.5 million SPECTRUM research cigarettes. On July 7, 2014, Goodrich Tobacco entered into a Teaming Agreement with RTI to work together to respond to a new request
from NIDA for the potential purchase by NIDA from RTI of additional SPECTRUM research cigarettes to be produced and sold by Goodrich Tobacco to RTI.
BRAND A and BRAND B
The Tobacco Control Act establishes procedures for the FDA to regulate the labeling and marketing of cigarettes that (i) reduce exposure to tobacco toxins and (ii) are
reasonably likely to pose lower health risks as compared to conventional cigarettes (“Modified Risk Cigarettes”). The Tobacco Control Act requires the FDA to issue specific
regulations and guidance regarding applications submitted to the FDA for the authorization to label and market modified risk tobacco products, including Modified Risk
Cigarettes. On March 30, 2012, the FDA issued Modified Risk Tobacco Product Applications Draft Guidance. We have been continuing to gather additional information since
the FDA’s draft guidance on the subject, including from the FDA, to submit complete applications for our two Modified Risk Cigarette candidates. Depending on how many
exposure studies and other information the FDA will require, it is likely that we will require additional capital to complete the entire FDA authorization process for our
Modified Risk Cigarettes.
Compared to commercial tobacco cigarettes, BRAND A has the lowest nicotine content. The tobacco in BRAND A contains approximately 95% less nicotine than
tobacco in leading “light” cigarette brands. Clinical studies have demonstrated that smokers who smoke VLN cigarettes containing our proprietary tobacco smoke fewer
cigarettes per day resulting in significant reductions in smoke exposure, including “tar,” nicotine and carbon monoxide. Due to the very low nicotine levels, compensatory
smoking does not occur with VLN cigarettes containing our proprietary tobacco (Hatsukami et al. 2010).
Using a proprietary high nicotine tobacco blend in conjunction with specialty cigarette components, BRAND B allows the smoker to achieve a satisfactory amount of
nicotine per cigarette while inhaling less “tar” and carbon monoxide. At the same time, we do not expect exposure to nicotine from BRAND B to be significantly higher than
some commercially available full flavor cigarette brands. We believe smokers who desire to reduce smoke exposure but are less concerned about nicotine will find BRAND B
beneficial. BRAND B has a “tar” yield between typical “light” and “ultra-light” cigarettes, but a nicotine yield of typical full flavor cigarettes.
Utilizing the results of previously conducted independent clinical trials (see below under “X-22 Smoking Cessation Aid”), we intend to submit to the Center for
Tobacco Products (“CTP”) of the FDA an application for BRAND A as a Modified Risk Cigarette.
Our Company has engaged a major contract research organization (“CRO”) with extensive experience in tobacco exposure studies to assist us in certain regulatory
activities at the CTP related to the Company’s research to support the development of potentially less harmful or modified risk cigarettes. The Company and the CRO met with
the CTP on November 12, 2014 to discuss the development plan and proof of concept study for BRAND B, a cigarette that produces smoke containing an extraordinarily low
amount of “tar” per milligram of nicotine.
We believe that these two cigarette products in development, which we refer to as BRAND A and BRAND B, will qualify as Modified Risk Cigarettes. Compared to
commercial cigarettes, the tobacco in BRAND A has approximately 95% less nicotine than tobacco in cigarettes previously marketed as “light” cigarettes, and BRAND B’s
smoke contains an extraordinarily low amount of “tar” per milligram of nicotine. However, there can be no assurance that BRAND A or BRAND B will be approved as Modified
Risk Cigarettes.
X-22 Smoking Cessation Aid
X-22 is a tobacco-based botanical medical product for use as an aid to smoking cessation. The X-22 therapy protocol utilized in our sponsored Phase IIb clinical trial
calls for the patient to smoke our VLN cigarettes over a six-week treatment period to facilitate the goal of the patient quitting smoking by the end of the treatment period. We
believe this therapy protocol has been successful in independent clinical trials because VLN cigarettes made from our proprietary tobacco satisfy smokers’ cravings for
cigarettes while (i) greatly reducing nicotine exposure and nicotine dependence and (ii) extinguishing the association between the act of smoking and the rapid delivery of
nicotine. X-22 involves the same smoking behavior as conventional cigarettes and because patients are simply switching to VLN cigarettes for 6 weeks, X-22 does not expose
the smoker to any new drugs or new side effects. Our Investigational New Drug Application for X-22, a kit of VLN cigarettes, was cleared by the FDA in July 2011 and has
been updated annually. Our X-22 Phase IIb clinical trial was completed in the first quarter of 2012 and did not demonstrate a statistically significant difference in quitting
between X-22 and the active control, a cigarette containing conventional nicotine levels. However, the median number of X-22 cigarettes smoked during the trial was
significantly reduced compared to patients’ baseline of usual brand of cigarettes. In evaluating the results of this trial, we believe we may have reduced the nicotine content of
X-22 by too great a percentage, to a level less than half the nicotine content of VLN cigarettes used in various independent smoking-cessation clinical trials that have
demonstrated that use of VLN cigarettes increases quit rates. The recently completed study led by the University of Pittsburgh with SPECTRUM research cigarettes of different
nicotine content produced by us for NIDA (ClinicalTrails.gov Identifier: NCT01681875) included 120 smokers that received VLN cigarettes with the same nicotine level as
used in the initial X-22 Phase IIb study and 120 smokers that received VLN cigarettes with the nicotine level used in the University of Minnesota and Queen Mary University
trials, as described below in greater detailed under “Smoking Cessation Clinical Trials with VLN Cigarettes.” Results from this study, which are expected to be available
shortly, will provide a direct comparison of smoker perception of and behavior with cigarettes of these nicotine contents.
12
Due to the limited effectiveness and/or serious side effects of existing FDA-approved smoking cessation products (all of which
have been on the market approximately between 8 and 30 years), we believe that if additional clinical trials demonstrate increased
smoking cessation rates, then X-22 can capture a share of this market by replacing sales and market share from existing smoking cessation
aids and expanding the smoking cessation market by encouraging more smokers to attempt to quit smoking. In contrast to the results of
our Phase IIb trial results, the following independent studies have demonstrated that VLN cigarettes increase quit rates, whether used
alone, in conjunction with Chantix® (varenicline) or nicotine replacement therapy (“NRT”) such as nicotine patches, gums or lozenges:
• Hatsukami DK, Kotlyar M, Hertsgaard LA, Zhang Y, Carmella SG, Jensen J, Allen SS, Shields PG, MurphySE, Stepanov I,
Hecht SS. 2010. Reduced nicotine content cigarettes: effects on toxicant exposure, dependence and cessation. Addiction
105:343-355.
•
Phase II clinical trial
•
Reduced nicotine content cigarettes and nicotine patch. Hatsukami DK, Hertsgaard LA, Vogel RI, Jensen JA, Murphy SE, Hecht
SS, Carmella SG, al'Absi M, Joseph AM, Allen SS. 2013. Reduced nicotine content cigarettes and nicotine patch. Cancer
Epidemiol Biomarkers Prev. 22(6):1015-24.
•
Phase II clinical trial
• Walker N, Howe C, Bullen C, Grigg M, Glover M, McRobbie H, Laugesen M, Parag V, Whittaker R. 2012. The combined effect
of very low nicotine content cigarettes, used as an adjunct to usual Quitline care (nicotine replacement therapy and behavioural
support), on smoking cessation: a randomized controlled trial. Addiction. 2012 Oct; 107(10):1857-67.
•
Phase III/IV clinical trial
•
•
Becker KM, Rose JE, Albino AP. 2008. A randomized trial of nicotine replacement therapy in combination with reduced-
nicotine cigarettes for smoking cessation. Nicotine Tob Res 10(7):1139-48.
•
Phase II clinical trial
Rezaishiraz H, Hyland A, Mahoney MC, O’Connor RJ, Cummings KM. 2007. Treating smokers before the quit date: can
nicotine patches and denicotinized cigarettes reduce cravings? Nicotine Tob Res. Nov; 9(11):1139-46.
•
Phase II clinical trial
A separate and yet unpublished clinical trial evaluated whether the use of our VLN cigarette in combination with Chantix® or in
combination with NRT increases abstinence rates over the use of Chantix® or the use of NRT (NCT01250301). Certain results of this
unpublished study were disclosed in a presentation at the 2013 Society for Research on Nicotine and Tobacco (“SRNT”) annual meeting
given by Hayden McRobbie, Ph.D. of Queen Mary University of London, Wolfson Institute of Preventative Medicine, who was the
principal investigator of the study. Pfizer Inc. was also a collaborator of the study. The study included one hundred smokers who were
prescribed varenicline (trademarked Chantix, or Champix outside the U.S.) and one hundred smokers who were prescribed NRT. Half the
smokers of each of these groups were randomly selected to also use our VLN cigarettes for the first 2 weeks of treatment. All smokers
received 9 weekly behavioral support sessions throughout the 12-week study period. The group that used our VLN cigarettes had a 70%
quit rate one week after stopping VLN cigarette use compared to a 53% quit rate of the group not using VLN cigarettes after week 1
(p=0.02). The group that used our VLN cigarettes had a 64% four-week continuous abstinence rate during weeks 3 to 6 compared to a
50% four-week continuous abstinence rate during weeks 1 to 4 (p=0.06). Quit rates at 12 weeks post treatment were not reported in the
presentation.
FDA approval must be obtained, as has been the case for decades, before a product can be marketed for quitting smoking. The
Tobacco Control Act provides that products for quitting smoking or smoking cessation, such as X-22, be considered for “Fast Track”
designation by the FDA. The “Fast Track” programs of the FDA are intended to facilitate development and expedite review of drugs to
treat serious and life-threatening conditions so that an approved product can reach the market expeditiously. We believe that upon
completion of a company-sponsored clinical trial demonstrating efficacy, X-22 will qualify for “Fast Track” designation by the FDA.
However, there is no guarantee that the FDA will grant “Fast Track” designation to X-22.
We believe that our VLN cigarettes are an effective aid to smoking cessation. We are currently in the process of identifying
potential joint venture partners or licensees to fund the remaining X-22 clinical trials. Upon identifying a suitable joint venture partner or
licensee, we will then request a meeting with the FDA, and thereafter we may resume our own sponsored X-22 clinical trials. There is no
guarantee that we will (ii) identify a joint venture partner or licensee to fund the remaining X-22 clinical trials, (ii) obtain the funds
necessary to complete additional clinical trials, (iii) obtain FDA approval, or (iv) capture significant share of the smoking cessation
market upon FDA approval.
13
Government Regulation
Smoking Cessation Aids
Government authorities in the U.S. and foreign countries extensively regulate the research, development, testing, manufacture,
labeling, promotion, advertising, distribution, sampling, marketing and import and export of pharmaceutical products. FDA approval must
be obtained, as has been the case for decades, before a product can be marketed for quitting smoking or reducing withdrawal symptoms.
In addition, as with all FDA-approved prescription drugs, the FDA must approve the brand name of our X-22 smoking cessation aid. The
FDA approval process for smoking cessation aids is similar to that required by the FDA for new drug approvals, although the cost to
complete clinical trials for a smoking cessation aid such as X-22 are generally far less than clinical trials for drugs. The primary endpoint
of the clinical trial for smoking cessation aids is smoking abstinence, which is generally confirmed by inexpensive, noninvasive
biomarker tests. Since potential quitters are already smokers, X-22 will not expose participants in the clinical trials to any new
compounds, unlike a new chemical entity, such as Chantix®.
The process of obtaining governmental approvals and complying with ongoing regulatory requirements requires the expenditure
of substantial time and financial resources. In addition, statutes, rules, regulations and policies may change and new legislation or
regulations may be issued that could delay such approvals. If we fail to comply with applicable regulatory requirements at any time during
the product development process, approval process, or after approval, we may become subject to administrative or judicial sanctions.
These sanctions could include the FDA’s refusal to approve pending applications, withdrawals of approvals, clinical holds, warning
letters, product recalls, product seizures, total or partial suspension of our operations, injunctions, fines, civil penalties or criminal
prosecution. Any agency enforcement action could have a material adverse effect on us.
The Affordable Care Act and other government and private sector initiatives targeted to potentially limit the growth of healthcare
costs are continuing in the U.S. and many other countries where we intend to sell our products, including our X-22 smoking cessation aid.
These changes are causing the marketplace to put increased emphasis on the delivery of more cost-effective medical products.
Government healthcare programs in the United States, including Medicare and Medicaid, private healthcare insurance and
managed-care plans have attempted to control costs by limiting the amount of reimbursement for which they will pay for particular
procedures or treatments. This may create price sensitivity among potential customers for our X-22 smoking cessation aid, even if we
obtain FDA approval for it. Some third-party payers must also approve coverage for new or innovative devices or therapies before they
will reimburse healthcare providers who use the medical devices or therapies. Even though a new medical product may have been cleared
for commercial distribution, we may find limited demand for X-22 until reimbursement approval has been obtained from governmental
and private third-party payers.
Modified Risk Cigarettes
The Tobacco Control Act, which became law in June 2009, prohibits the FDA from banning cigarettes outright or mandating that
nicotine levels be reduced to zero. However, among other things, it allows the FDA to require the reduction of nicotine or any other
compound in cigarettes. In 2009, the Tobacco Control Act banned all sales in the United States of cigarettes with flavored tobacco (other
than menthol). As of June 2010, all cigarette companies were required to cease using the terms “low tar,” “light” and “ultra light” in
describing cigarettes sold in the United States. We believe this new regulatory environment represents a paradigm shift for the tobacco
industry and will create opportunities for us in marketing BRAND A and BRAND B and in licensing our proprietary technology and/or
tobaccos to larger competitors.
For the first time in history, a U.S. regulatory agency will scientifically evaluate cigarettes that may pose lower health risks as
compared to conventional cigarettes. The Tobacco Control Act establishes procedures for the FDA to regulate the labeling and marketing
of modified risk tobacco products, which includes cigarettes that (i) reduce exposure to tobacco smoke toxins and/or (ii) pose lower health
risks, as compared to conventional cigarettes (“Modified Risk Cigarettes”). The Tobacco Control Act requires the FDA to issue specific
regulations and guidance regarding applications that must be submitted to the FDA for the authorization to label and market Modified
Risk Cigarettes. We believe that BRAND A and BRAND B will qualify as Modified Risk Cigarettes. We will need significant additional
capital to complete the FDA authorization process for our Modified Risk Cigarettes. The amount of capital is currently unknown since it
is uncertain how many exposure studies the FDA will require for BRAND A and BRAND B. In addition, the Tobacco Control Act allows
the FDA to mandate the use of reduced risk technologies in conventional tobacco products and cigarettes (e.g., Marlboro®) which could
create opportunities for us to license our proprietary technology and/or our tobaccos to larger competitors.
In addition to providing our SPECTRUM cigarettes to NIDA for researchers, we have been directly supplying our proprietary
cigarettes to independent researchers so that additional studies can be conducted to obtain additional information on our products. We
expect this information will assist us, along with our own funded studies, in obtaining the necessary FDA authorizations to market
BRAND A and BRAND B as Modified Risk Cigarettes and to obtain FDA approval for X-22 as a prescription smoking cessation aid.
14
Competition
In the market for FDA-approved smoking cessation aids, our principal competitors include Pfizer Inc., GlaxoSmithKline plc, Novartis
International AG, and Perrigo Company plc. The industry consists of major domestic and international companies, most of which have existing
relationships in the markets into which we plan to sell, as well as financial, technical, marketing, sales, manufacturing, scaling capacity, distribution and
other resources, and name recognition substantially greater than ours.
Cigarette companies compete primarily on the basis of product quality, brand recognition, brand loyalty, taste, innovation, packaging, service,
marketing, advertising, retail shelf space and price. Cigarette sales can be significantly influenced by weak economic conditions, erosion of consumer
confidence, competitors’ introduction of low-price products or innovative products, higher cigarette taxes, higher absolute prices and larger gaps between
price categories, and product regulation that diminishes the ability to differentiate tobacco products. Domestic competitors include Philip Morris USA,
Reynolds American Inc., Lorillard Inc., Commonwealth Brands, Inc., Liggett Group LLC and Vector Tobacco Inc. International competitors include
Philip Morris International, Inc., Japan Tobacco Inc., Imperial Tobacco Group plc, and regional and local tobacco companies.
Biomass Products
Biomass products are products such as ethanol made from the organic material, usually plants densely grown over a given area. We have funded
extensive biomass field trials conducted by NCSU and work on feedstock digestibility and bioconversion at the National Renewable Energy Lab.
Bioconversion is the conversion of organic matter into a source of energy, such as ethanol in our own research, through the action of microorganisms.
Tobacco has a number of advantages as a starting point for development of novel bioproduct crop systems. Because tobacco is a widely cultivated crop,
grown in over 100 countries throughout the world, tobacco agronomy is highly understood. For decades tobacco has been used as a model system for plant
biology, and recently the tobacco genome has been mapped. Tobacco plants rapidly sprout back after each harvest and produce large amounts of leaf and
total biomass. Tobacco grown for cigarettes yields about 3,000 pounds of cured leaf per acre (~20% moisture) per year from 7,500 tobacco plants. In our
field trials in North Carolina, nicotine-free tobacco grown for biomass yields about 100,000 pounds of fresh weight per acre (which equals 10,000 pounds
of dry weight) per year with multiple machine harvests from about 80,000 tobacco plants. The results of our biomass studies have been summarized in a
comprehensive feasibility study relating to our nicotine-free tobacco biomass crop (Verfola) to produce a variety of bioproducts. First, protein and other
plant fractions are extracted, and then biofuels and other products are produced from the remaining cellulosic residue.
In 2009, we put our biomass development projects on hold so that our management could focus its attention and resources on our modified risk
cigarette business and our X-22 smoking cessation business. We do not plan to move forward with potential biomass business activities until some period
of time after FDA approval of X-22 or FDA authorization to market Brand A or Brand B as a Modified Risk Cigarette. We currently are not spending any
capital for such potential biomass business activities nor do we have any current plans to do so in the foreseeable future.
Cannabis Research in Canada
Botanical Genetics is a wholly-owned subsidiary of the Company and was incorporated to facilitate an equity investment in Anandia
Laboratories, Inc. (“Anandia”), a plant biotechnology company based in Vancouver, Canada, that closed on April 14, 2014. On September 15, 2014,
Botanical Genetics was granted a sublicense by Anandia to 23 patent applications relating to four genes in the cannabis plant that are required for the
production of cannabinoids, the active ingredients in the cannabis plant, with such sublicense being exclusive in the United States and co-exclusive with
Anandia everywhere else in the world, except Canada where Anandia has retained exclusive rights. The Anandia sublicense continues through the life of
the last-to-expire patent, which is expected to be in 2035.
We do not conduct any activities related to cannabis in the United States. Our research facilities for cannabis are located exclusively in Canada.
Through licenses granted by the Canadian government to Anandia, we will be conducting research and development in Canada with Anandia of unique
plant varieties of hemp/cannabis, such as (i) plants with low to no amounts of delta-9-tetrahydrocannabinol, or THC, for the legal hemp industry, (ii) plants
with high levels of THC for the legal recreational cannabis market, and (iii) plants with high levels of cannabidiol, or CBD, and other non-THC
cannabinoids for the legal medical marijuana markets. In Canada, licenses to cultivate, possess and supply cannabis for medical research are granted by
agencies of the Canadian federal government. In order to carry out research in other countries, similar licenses are required to be issued by the relevant
authority in each country.
As of December 31, 2014, there are 23 states in the United States plus the District of Columbia that have laws and/or regulations that recognize,
in one form or another, legitimate medical uses for cannabis and consumer use of cannabis in connection with medical treatment. Additionally, the states
of Colorado and Washington have legalized cannabis for adult use. Furthermore, the states of Alaska and Oregon have approved legalized cannabis for
adult use in laws that will become effective in 2015. Many other states are considering similar legislation. Conversely, under the federal Controlled
Substance Act (the “CSA”), the policies and regulations of the federal government and its agencies are that cannabis has no medical benefit and a range of
activities are prohibited, including cultivation, possession, personal use and interstate distribution of cannabis. In the event the U.S. Department of Justice
(the “DOJ”) begins strict enforcement of the CSA in states that have laws legalizing medical marijuana and recreational marijuana in small amounts, there
may be a direct and adverse impact to any future business or prospects that we have in the cannabis business.
Employees
We currently employ twenty three (23) people and we consider our employee relations to be good.
15
Item 1A.
Risk Factors.
You should carefully consider the risk factors set forth below and in other reports that we file from time to time with the Securities and Exchange
Commission and the other information in this Annual Report on Form 10-K. The matters discussed in the risk factors, and additional risks and
uncertainties not currently known to us or that we currently deem immaterial, could have a material adverse effect on our business, financial condition,
results of operation and future growth prospects and could cause the trading price of our common stock to decline.
Risks Related to Our Business and Operations
We have had a history of losses, and we may be unable to achieve and sustain profitability.
We have experienced net losses of approximately $15.6 million, $26.1 million and $6.7 million during the years ended December 31, 2014, 2013
and 2012, respectively. At December 31, 2014, we had current assets of $10,706,806, current liabilities of $2,673,407, and cash on hand of $6,402,687.
We believe the cash balance is adequate to sustain operations and meet all current obligations as they come due for a period of approximately 12 months.
Excluding contract growing of our proprietary tobacco with farmers, extraordinary expenses such as potential clinical trials, capital expenditures for our
factory, and initial expenses associated with the launch of our RED SUN cigarette brand, our monthly cash expenditures are approximately $500,000.
While our current cash balance is adequate to sustain operations for approximately 12 months, generating net income in the future will depend on our
ability to successfully operate our cigarette manufacturing facility, sell and market our proprietary tobacco products and generate additional royalty
revenue from the licensing our intellectual property. There is no guarantee that we will be able to achieve or sustain profitability in the future. An inability
to successfully achieve profitability may decrease our long-term viability.
We have had a history of negative cash flow, and our ability to sustain positive cash flow is uncertain.
We have had a history of negative cash flow from operating activities, before cash used in investing activities and cash from financing activities,
including approximately $6.6 million during the year ended December 31, 2014. As indicated above, we believe our cash on hand is adequate to sustain
operations and meet all current obligations as they come due for a period in excess of 12 months. Continued generation of positive cash flow from
operations will depend on our ability to successfully implement the net income generating activities discussed in the previous risk factor discussion. An
inability to successfully implement our net income producing initiatives may decrease our long-term viability.
Our limited operating history makes it difficult to evaluate our current business and future prospects.
We have been in existence since 1998, but our activities have been previously limited primarily to licensing and funding research and
development activities. Our limited operating history may make it difficult to evaluate our current business and our future prospects. We have encountered
and will continue to encounter risks and difficulties frequently experienced by growing companies in rapidly changing industries, including increasing
expenses as we continue to grow our business. If we do not manage these risks successfully, our business will be harmed.
We will mainly depend on third parties to market, sell and distribute our products, and we currently have no commercial arrangements for the
marketing, sale or distribution of our X-22 smoking cessation aid.
We expect to depend on third parties to a great extent to market, sell and distribute our products and we currently have no arrangements with third
parties in place to provide such services for our X-22 smoking cessation aid. We cannot be sure that we will be able to enter into such arrangements on
acceptable terms, or at all. If we are unable to enter into marketing, sales and distribution arrangements with third parties for our X-22 smoking cessation
aid, we would need to incur significant sales, marketing and distribution expenses in connection with the commercialization of X-22 and any future
potential products. We do not currently have a dedicated sales force, and we have no experience in the sales, marketing and distribution of pharmaceutical
products. Developing a sales force is expensive and time-consuming, and we may not be able to develop this capacity. If we are unable to establish
adequate sales, marketing and distribution capabilities, independently or with others, we may not be able to generate significant revenue and may not
become profitable.
We have no experience in managing growth. If we fail to manage our growth effectively, we may be unable to execute our business plan or address
competitive challenges adequately.
During 2014, we grew from nine (9) to twenty three (23) employees. Any growth in our business will place a significant strain on our managerial,
administrative, operational, financial, information technology and other resources. We intend to further expand our overall business, customer base,
employees and operations, which will require substantial management effort and significant additional investment in our infrastructure. We will be
required to continue to improve our operational, financial and management controls and our reporting procedures and we may not be able to do so
effectively. As such, we may be unable to manage our growth effectively.
Our working capital requirements involve estimates based on demand expectations and may increase beyond those currently anticipated, which could
harm our operating results and financial condition.
We have no experience in selling Modified Risk Cigarettes or smoking cessation products on a commercial basis. As a result, we intend to base
our funding and inventory decisions on estimates of future demand. If demand for our products does not increase as quickly as we have estimated, our
inventory and expenses could rise, and our business and operating results could suffer. Alternatively, if we experience sales in excess of our estimates, our
working capital needs may be higher than those currently anticipated. Our ability to meet any demand for our products may depend on our ability to
arrange for additional financing for any ongoing working capital shortages, since it is likely that cash flow from sales will lag behind our investment
requirements.
16
We have limited experience in operating and managing a manufacturing facility.
We have limited experience operating and managing a manufacturing facility. The manufacture of products are subject to strict
quality control, testing and record keeping requirements, and continuing obligations regarding the submission of safety reports and other
post-market information. In addition, the manufacturing of our own products will be expensive to operate without sufficient production
volume. If we are unable to successfully manufacture or sell our products, we will still be liable for the costs associated with operating a
manufacturing facility. Accordingly, the operation of such manufacturing facility could have a material adverse effect on our results of
operations.
Our manufacturing facility is subject to FDA regulations.
Manufacturers of tobacco and pharmaceutical products must comply with FDA regulations which require, among other things,
compliance with the FDA’s evolving regulations on Current Good Manufacturing Practices (“cGMP(s)”), which are enforced by the FDA
through its facilities inspection program. The manufacture of products are subject to strict quality control, testing and record keeping
requirements, and continuing obligations regarding the submission of safety reports and other post-market information. We cannot
guarantee that our current manufacturing facility will pass FDA and/or similar inspections in foreign countries to produce our tobacco
products or the final version of our X-22 smoking cessation aid, or that future changes to cGMP manufacturing standards will not also
negatively affect the cost or sustainability of our manufacturing facility.
We will likely require additional capital before we can complete the FDA authorization process for our X-22 smoking cessation aid
and our Modified Risk Cigarettes.
We are currently seeking a suitable joint venture partner or licensee willing to fund further clinical trials for FDA approval of our
X-22 smoking cessation aid. At that time we will resume our own sponsored X-22 clinical trials. There is no guarantee that we will
identify a joint venture partner or licensee willing to fund further X-22 clinical trials on terms that are acceptable to us. We estimate the
cost of completing two Phase III trials to be approximately $20 million. We will also likely require additional capital in the future before
we can complete the FDA authorization process for our Modified Risk Cigarettes. The cost of completing the FDA authorization process
for each of our two potential Modified Risk Cigarettes is difficult to estimate since it is currently unknown exactly what the FDA will
require, including the number and size of exposure studies. If we raise additional funds through the issuance of equity securities to
complete the FDA authorization process for our Modified Risk Cigarettes, our stockholders may experience substantial dilution, or the
equity securities may have rights, preferences or privileges senior to those of existing stockholders. If we raise additional funds through
debt financings, these financings may involve significant cash payment obligations and covenants that restrict our ability to operate our
business and make distributions to our stockholders. We could also wait for our own revenues and profits to be sufficient for us to provide
such funding, which could delay our completion of the FDA authorization process for our Modified Risk Cigarettes. We also could elect
to seek funds through arrangements with collaborators or licensees. To the extent that we raise additional funds through collaboration and
licensing arrangements, it may be necessary to relinquish some rights to our technologies or our potential products or grant licenses on
terms that are not favorable to us.
If we choose to resume and fund our own clinical trials for FDA approval of our X-22 smoking cessation product and we cannot
raise additional capital on acceptable terms, we may not be able to, among other things:
• complete clinical trials of our X-22 smoking cessation aid;
• undertake the steps necessary to seek FDA authorization of our Modified Risk Cigarettes;
• develop or enhance our potential products or introduce new products;
• expand our development, sales and marketing and general and administrative activities;
• attract tobacco growers, customers or manufacturing and distribution partners;
• acquire complementary technologies, products or businesses;
• expand our operations in the United States or internationally;
• hire, train and retain employees; or
• respond to competitive pressures or unanticipated working capital requirements.
17
If our X-22 smoking cessation aid does not gain market acceptance among physicians, patients, third-party payers and the medical
community, we may be unable to generate significant revenue.
Our X-22 smoking cessation aid may not achieve market acceptance among physicians, patients, third-party payers and others in
the medical community. If we receive FDA approval for the marketing of X-22 as a smoking cessation aid in the U.S., the degree of
market acceptance could depend upon a number of factors, including:
•
•
•
•
•
limitations on the indications for use for which X-22 may be marketed;
the establishment and demonstration in the medical community of the clinical efficacy and safety of our potential products
and their potential advantages over existing products;
the prevalence and severity of any side effects;
the strength of marketing and distribution support; and
sufficient third-party coverage or reimbursement.
The market may not accept our X-22 smoking cessation aid, based on any number of the above factors. Even if the FDA
approves the marketing of X-22 as a smoking cessation aid, there are other FDA-approved products available and there will also be future
competitive products which directly compete with X-22. The market may prefer such existing or future competitive products for any
number of reasons, including familiarity with or pricing of such products. The failure of any of our potential products to gain market
acceptance could impair our ability to generate revenue, which could have a material adverse effect on our future business, financial
condition, results of operations and cash flows.
18
Our principal competitors in the smoking cessation market have, and any future competitors may have, greater financial and
marketing resources than we do, and they may therefore develop products or other technologies similar or superior to ours or
otherwise compete more successfully than we do.
We have no experience in selling smoking cessation products. Competition in the smoking cessation aid products industry is
intense, and we may not be able to successfully compete in the market. In the market for FDA-approved smoking cessation aids, our
principal competitors include Pfizer Inc., GlaxoSmithKline plc, Perrigo Company plc and Novartis International AG. The industry
consists of major domestic and international companies, most of which have existing relationships in the markets which we plan to sell, as
well as financial, technical, marketing, sales, manufacturing, scaling capacity, distribution and other resources and name recognition
substantially greater than ours. In addition, we expect new competitors will enter the markets for our products in the future. Potential
customers may choose to do business with our more established competitors, because of their perception that our competitors are more
stable, are more likely to complete various projects, can scale operations more quickly, have greater manufacturing capacity, are more
likely to continue as a going concern and lend greater credibility to any joint venture. If we are unable to compete successfully against
manufacturers of other smoking cessation products, our business could suffer, and we could lose or be unable to obtain market share.
We face intense competition in the market for our RED SUN and MAGIC cigarettes and our BRAND A and BRAND B cigarettes, and
our failure to compete effectively could have a material adverse effect on our profitability and results of operations.
Cigarette companies compete primarily on the basis of product quality, brand recognition, brand loyalty, taste, innovation,
packaging, service, marketing, advertising, retail shelf space and price. We are subject to highly competitive conditions in all aspects of
our business and we may not be able to effectively market and sell our RED SUN and MAGIC cigarettes or other cigarettes we may
introduce to the market such as our BRAND A and BRAND B cigarettes as Modified Risk Cigarettes, upon FDA authorization. The
competitive environment and our competitive position can be significantly influenced by weak economic conditions, erosion of consumer
confidence, competitors’ introduction of low-price products or innovative products, higher cigarette taxes, higher absolute prices and
larger gaps between price categories, and product regulation that diminishes the ability to differentiate tobacco products. Domestic
competitors include Philip Morris USA Inc., Reynolds American Inc., Lorillard Inc., Commonwealth Brands, Inc., Liggett Group LLC,
and Vector Tobacco Inc. International competitors include Philip Morris International Inc., JT International SA, Imperial Tobacco Group
plc and regional and local tobacco companies.
Our competitors may develop products that are less expensive, safer or more effective, which may diminish or eliminate the
commercial success of any potential product that we may commercialize.
If our competitors market products that are less expensive, safer or more effective than our potential products, or that reach the
market before our potential products, we may not achieve commercial success. The market may choose to continue utilizing existing
products for any number of reasons, including familiarity with or pricing of these existing products. The failure of our X -22 smoking
cessation aid or our cigarette brands to compete with products marketed by our competitors would impair our ability to generate revenue,
which would have a material adverse effect on our future business, financial condition, results of operations and cash flows. Our
competitors may:
•
•
•
develop and market products that are less expensive or more effective than our products;
commercialize competing products before we or our partners can launch our products; and
initiate or withstand substantial price competition more successfully than we can.
If we fail to stay at the forefront of technological change, we may be unable to compete effectively.
Our competitors may render our technologies obsolete by advances in existing technological approaches or the development of
new or different approaches, potentially eliminating the advantages that we believe we derive from our research approach and proprietary
technologies. Our competitors may:
operate larger research and development programs or have substantially greater financial resources than we do;
have greater success in recruiting skilled technical and scientific workers from the limited pool of available talent;
•
•
• more effectively negotiate third-party licenses and strategic relationships; and
take advantage of acquisition or other opportunities more readily than we can.
•
19
Government mandated prices, production control programs, shifts in crops driven by economic conditions and adverse weather
patterns may increase the cost or reduce the quality of the tobacco and other agricultural products used to manufacture our products.
We depend upon independent tobacco farmers to grow our specialty proprietary tobaccos with specific nicotine contents for our
products. As with other agricultural commodities, the price of tobacco leaf can be influenced by imbalances in supply and demand, and
crop quality can be influenced by variations in weather patterns, diseases and pests. We must also compete with other tobacco companies
for contract production with independent tobacco farmers. Tobacco production in certain countries is subject to a variety of controls,
including government mandated prices and production control programs. Changes in the patterns of demand for agricultural products
could cause farmers to plant less tobacco. Any significant change in tobacco leaf prices, quality and quantity could affect our profitability
and our business.
Our future success depends on our ability to retain key personnel.
Our success will depend to a significant extent on the continued services of our senior management team, and in particular Henry
Sicignano III, our President and Chief Operating Officer, John Brodfuehrer, our Chief Financial Officer, Michael Moynihan, Ph.D., our
Vice President of R&D, and Thomas James, Esq., our Vice President, General Counsel and Secretary. The loss or unavailability of any of
these individuals may significantly delay or prevent the development of our potential products and other business objectives by diverting
management’s attention to transition matters. While each of these individuals is party to employment agreements with us, they could
terminate their relationships with us at any time, and we may be unable to enforce any applicable employment or non-compete
agreements.
We also rely on consultants and advisors to assist us in formulating our research and development, manufacturing, distribution,
marketing and sales strategies. All of our consultants and advisors are either self-employed or employed by other organizations, and they
may have conflicts of interest or other commitments, such as consulting or advisory contracts with other organizations, that may affect
their ability to contribute to us.
Product liability claims, product recalls or other claims could cause us to incur losses or damage our reputation.
The risk of product liability claims or product recalls, and associated adverse publicity, is inherent in the development,
manufacturing, marketing and sale of tobacco and smoking cessation products. We do not currently have product liability insurance for
our products or our potential products and do not expect to be able to obtain product liability insurance at reasonable commercial rates for
these products. Any product recall or lawsuit seeking significant monetary damages may have a material adverse effect on our business
and financial condition. A successful product liability claim against us could require us to pay a substantial monetary award. We cannot
assure you that such claims will not be made in the future.
Negative press from entering the cannabis space could have a material adverse effect on our business, financial condition and results
of operations.
Despite growing support for the cannabis industry and legalization of cannabis in certain U.S. states, many individuals and
businesses remain opposed to the cannabis industry. Any negative press resulting from our recent entry into the cannabis space could
result in a loss of current or future business. It could also adversely affect the public’s perception of us and lead to reluctance by new
parties to do business with us or to own our common stock. We cannot assure you that additional business partners, including but not
limited to financial institutions and customers, will not attempt to end or curtail their relationships with us. Any such negative press or
cessation of business could have a material adverse effect on our business, financial condition and results of operations.
Any business related cannabinoid production is dependent on laws pertaining to the cannabis industry.
As of December 31, 2014, 23 states and the District of Columbia allow their citizens to use medical marijuana. Additionally, the
states of Colorado and Washington have legalized cannabis for adult use. Furthermore, the states of Alaska and Oregon have approved
legalized cannabis for adult use in laws that will become effective in 2015. The state laws are in conflict with the federal Controlled
Substances Act, or CSA, which makes marijuana use, possession and interstate distribution illegal on a federal level.
20
We do not currently conduct any activities related to cannabis in the United States. Our research facilities for cannabis are
located exclusively in Canada. In Canada, licenses to cultivate, possess and supply cannabis for medical research are granted by agencies
of the federal government in Canada. In order to carry out research in other countries, similar licenses are required to be issued by the
relevant authority in each country.
Local, state, federal and international medical marijuana laws and regulations are broad in scope and subject to evolving
interpretations, which could require us to incur substantial costs associated with compliance requirements. In addition, violations of these
laws, or allegations of such violations, could disrupt our business and result in a material adverse effect on our operations. In addition, it is
possible that regulations may be enacted in the future that will be directly applicable to our proposed business regarding cannabinoid
production. We cannot predict the nature of any future laws, regulations, interpretations or applications, nor can we determine what effect
additional governmental regulations or administrative policies and procedures, when and if promulgated, could have on our proposed
business.
Risks Related to Regulatory Approvals and Insurance Reimbursement
If we fail to obtain FDA and foreign regulatory approvals of X-22 as a smoking cessation aid and FDA authorization to market
BRAND A and BRAND B as Modified Risk Cigarettes, we will be unable to commercialize these potential products in and outside the
U.S., other than the sale of our BRAND A and BRAND B cigarettes as conventional cigarettes.
There can be no assurance that our X-22 smoking cessation aid will be approved by the FDA, European Medicines Agency
(“EMA”), or any other governmental body. In addition, there can be no assurance that all necessary approvals will be granted for our
potential products or that review or actions will not involve delays caused by requests for additional information or testing that could
adversely affect the time to market for and sale of our potential products. Our ability to complete the FDA-approval process in a timely
manner is dependent, in part, on our ability to obtain “Fast Track” designation for X-22 by the FDA.
We submitted a request for Fast Track designation for X-22, and on August 18, 2011, the FDA informed us that it would not
grant the designation of X-22 as a Fast Track product at that time because we had not yet demonstrated that X-22 showed potential to
address an unmet medical need. Except for our Phase IIb clinical trial, all smoking cessation studies with VLN cigarettes containing our
proprietary tobacco were independent studies and were not sponsored by us under our own IND application. We plan to reapply for Fast
Track designation, but not until results of a clinical trial conducted by us demonstrates an advantage (over currently approved smoking
cessation products) in one of the following areas: efficacy, safety or improvement in some other factor such as compliance (a patient using
a product as directed) or convenience. There is no guarantee that the FDA will grant Fast Track designation to X-22. We may also not
obtain Priority Review of our X-22 New Drug Application (“NDA”), which would further delay FDA approval of X-22. The length of the
FDA’s review of a NDA without a Priority Review designation is normally ten months from the date of filing of the NDA, although it is
possible in certain cases for such review time to be longer. However, the FDA’s goal for reviewing a product with Priority Review status
is normally six months from the date of the filing of a NDA. If we do not obtain Priority Review of our NDA, we would then expect the
timing of FDA approval of X-22 to be extended several additional months. Even if X-22 is approved by the FDA, the FDA may require
the product to only be prescribed to patients who have already failed to quit smoking with another approved therapy. Further, failure to
comply with applicable regulatory requirements can, among other things, result in the suspension of regulatory approval as well as
possible civil and criminal sanctions.
21
The development, testing, manufacturing and marketing of our potential products are subject to extensive regulation by
governmental authorities in the United States and throughout the world. In particular, the process of obtaining approvals by the FDA, the
EMA and other international FDA equivalent agencies in targeted countries is costly and time consuming, and the time required for such
approval is uncertain. Our X-22 smoking cessation aid must undergo rigorous clinical testing and an extensive regulatory approval process
mandated by the FDA or EMA. Such regulatory review includes the determination of manufacturing capability and product performance.
Generally, only a small percentage of pharmaceutical products are ultimately approved for commercial sale.
The scope of review, including product testing and exposure studies, to be required by the FDA under the Tobacco Control Act
in order for cigarettes such as BRAND A and BRAND B to be marketed as Modified Risk Cigarettes has not yet been fully established,
even though the FDA issued Modified Risk Tobacco Product Applications Draft Guidance on March 30, 2012. We may be unsuccessful
in establishing that BRAND A or BRAND B are Modified Risk Cigarettes, and we may fail to demonstrate that either BRAND A or BRAND
B significantly reduces exposure to certain tobacco smoke toxins. Even upon demonstrating significant reduced exposure to certain
tobacco smoke toxins, the FDA may decide that allowing a modified risk claim is not in the best interest of the public health, and the FDA
may not allow us to market our BRAND A and/or BRAND B cigarettes as Modified Risk Cigarettes.
The FDA could force the removal of our products from the U.S. market.
The FDA could force us to remove from the U.S. market our tobacco products such as RED SUN or MAGIC since these are not
grandfathered products under the Tobacco Control Act, and the FDA could force us to remove from the U.S. market BRAND A and/or
BRAND B even after FDA authorization to market BRAND A and BRAND B as Modified Risk Cigarettes.
We intend to distribute and sell our potential products outside of the United States, which will subject us to other regulatory risks.
In addition to seeking approval from the FDA for our X-22 smoking cessation aid in the United States, we intend to seek
governmental approvals required to market X-22 and our other potential products in other countries. Marketing of our X-22 smoking
cessation aid is not permitted in certain countries until we have obtained required approvals or exemptions in the individual country. The
regulatory review process varies from country to country, and approval by foreign governmental authorities is unpredictable, uncertain
and generally expensive. Our ability to market our potential products could be substantially limited due to delays in receipt of, or failure
to receive, the necessary approvals or clearances. We anticipate commencing the applications required in some or all of these countries
following approval by the FDA; however, we may decide to file applications in advance of the FDA approval if we determine such filings
to be both time and cost effective. If we export any of our potential products or products that have not yet been cleared for commercial
distribution in the United States, such products may be subject to FDA export restrictions. Failure to obtain necessary regulatory
approvals could impair our ability to generate revenue from international sources.
Market acceptance of our X-22 smoking cessation aid could be limited if users are unable to obtain adequate reimbursement from
third-party payers.
Government health administration authorities, private health insurers and other organizations generally provide reimbursement
for FDA-approved smoking cessation products, and our commercial success could depend in part on these third-party payers agreeing to
reimburse patients for the costs of our X-22 smoking cessation aid. Even if we succeed in bringing our X-22 smoking cessation aid to
market, there is no assurance that third-party payers will consider X-22 cost effective or provide reimbursement in whole or in part for its
use.
Significant uncertainty exists as to the reimbursement status of newly approved health care products. Our X-22 smoking
cessation aid is intended to replace or alter existing therapies or procedures. These third-party payers may conclude that our X-22 smoking
cessation aid is less safe, effective or cost-effective than these existing therapies or procedures. Therefore, third-party payers may not
approve X-22 for reimbursement.
If third-party payers do not approve X-22 or our potential products for reimbursement or fail to reimburse for them adequately,
sales could suffer as some physicians or their patients could opt for a competing product that is approved for reimbursement or is
adequately reimbursed. Even if third-party payers make reimbursement available, these payers’ reimbursement policies may adversely
affect our ability and the ability of our potential collaborators to sell our potential products on a profitable basis.
The trend toward managed healthcare in the United States, such as the Affordable Care Act enacted on March 23, 2010, and
legislative proposals to reform healthcare and government insurance programs could significantly influence the purchase of healthcare
services and products, resulting in lower prices and reduced demand for our potential products which could adversely affect our business,
financial condition, results of operations and cash flows.
22
In addition, legislation and regulations affecting the pricing of our potential products may change in ways adverse to us before or
after the FDA or other regulatory agencies approve any of our potential products for marketing. While we cannot predict the likelihood of
any of these legislative or regulatory proposals, if any government or regulatory agency adopts these proposals, they could materially
adversely affect our business, financial condition, results of operations and cash flows.
Our clinical trials for any of our potential products may produce negative or inconclusive results and we may decide, or regulators
may require us, to conduct additional clinical and/or preclinical testing for these potential products or cease our trials.
We do not know whether clinical trials of our potential products will demonstrate safety and efficacy sufficiently to result in
marketable products. Because our clinical trials for our X-22 smoking cessation aid and any other potential products may produce
negative or inconclusive results, we may decide, or regulators may require us, to conduct additional clinical and/or preclinical testing for
these potential products or cease our clinical trials. If this occurs, we may not be able to obtain approval or marketing authorization for
these potential products or our anticipated time of bringing these potential products to the market may be substantially delayed and we
may also experience significant additional development costs. We may also be required to undertake additional clinical testing if we
change or expand the indications for our potential products.
Risks Related to the Tobacco Industry
Our business faces significant governmental action aimed at increasing regulatory requirements with the goal of preventing the use of
tobacco products.
Cigarette companies face significant governmental action, especially in the United States pursuant to the Tobacco Control Act,
including efforts aimed at reducing the incidence of tobacco use, restricting marketing and advertising, imposing regulations on
packaging, warnings and disclosure of flavors or other ingredients, prohibiting the sale of tobacco products with certain flavors or other
characteristics, limiting or prohibiting the sale of tobacco products by certain retail establishments and the sale of tobacco products in
certain packaging sizes, and seeking to hold retailers and distributors responsible for the adverse health effects associated with both
smoking and exposure to environmental tobacco smoke. Governmental actions, combined with the diminishing social acceptance of
smoking and private actions to restrict smoking, have resulted in reduced industry volume in the United States and certain other countries,
and we expect that these factors will continue to reduce consumption levels in these countries.
Certain of such actions may have a favorable impact on our X-22 smoking cessation aid, or on our BRAND A and BRAND B
cigarettes if we are able to market them as Modified Risk Cigarettes. However, there is no assurance of such favorable impact and such
actions may have a negative impact on our ability to market RED SUN and MAGIC.
Significant regulatory developments will take place over the next few years in many markets, driven principally by the World
Health Organization’s Framework Convention on Tobacco Control (“FCTC”). The FCTC is the first international public health treaty on
tobacco, and its objective is to establish a global agenda for tobacco regulation with the purpose of reducing initiation of tobacco use and
encouraging cessation. In addition, the FCTC has led to increased efforts by tobacco control advocates and public health organizations to
reduce the appeal of tobacco products. Partly because of some or a combination of these efforts, unit sales of tobacco products in certain
markets, principally Western Europe and Japan, have been in general decline and we expect this trend to continue. Our operating results
could be significantly affected by any significant decrease in demand for cigarettes, any significant increase in the cost of complying with
new regulatory requirements and requirements that lead to a commoditization of tobacco products such as the implementation of plain
packaging in Australia.
23
If implemented in the future, the FDA requirement regarding graphic health warnings on cigarette packaging and in cigarette advertising is likely to
have a negative impact on sales of our products.
In November 2010, as required by the Tobacco Control Act, the FDA issued a proposed rule to modify the required warnings that appear on
cigarette packages and in cigarette advertisements. These warning were finalized on June 21, 2011 and consist of nine new textual warning statements
accompanied by color graphics depicting the negative health consequences of smoking. The FDA selected nine images from the originally proposed 36
images after reviewing the relevant scientific literature, analyzing the results from an 18,000 person study and considering more than 1,700 comments
from a variety of groups. The graphic health warnings were to be located beneath the cellophane wrapping on cigarette packages, and will comprise the top
50 percent of the front and rear panels of cigarette packages. The graphic health warnings will occupy 20 percent of a cigarette advertisement and will be
located at the top of the advertisement. Each warning is accompanied by a smoking cessation phone number, 1-800-QUIT-NOW. Although these graphic
health warnings were supposed to be implemented in September 2012, a federal judge ruled that these warnings are unconstitutional. If and when these
graphic health warnings are implemented, all cigarettes manufactured for sale or distribution in the United States will need to include these new graphic
health warnings on their packages. Any reduction in the number of smokers will probably reduce the demand for MAGIC and RED SUN, as well as X-22,
BRAND A and BRAND B, if and when implemented by the FDA. MAGIC, RED SUN, BRAND A and BRAND B will be subject to these new packaging and
advertising regulations. It is unclear at this time whether the FDA may require X-22 and SPECTRUM to be subject to these new packaging and advertising
regulations.
We may become subject to litigation related to cigarette smoking and exposure to environmental tobacco smoke, or ETS, which could severely impair
our results of operations and liquidity.
Although we are not currently subject to legal proceedings, we may become subject to litigation related to the sale of our RED SUN and MAGIC
cigarettes and, upon FDA authorization, our BRAND A and BRAND B cigarettes. Legal proceedings covering a wide range of matters related to tobacco
use are pending or threatened in various U.S. and foreign jurisdictions. Various types of claims are raised in these proceedings, including product liability,
consumer protection, antitrust, tax, contraband shipments, patent infringement, employment matters, claims for contribution and claims of competitors and
distributors.
Litigation is subject to uncertainty and it is possible that there could be adverse developments in pending cases. An unfavorable outcome or
settlement of pending tobacco related litigation could encourage the commencement of additional litigation. The variability in pleadings, together with the
actual experience of management in litigating claims, demonstrates that the monetary relief that may be specified in a lawsuit bears little relevance to the
ultimate outcome.
Damages claimed in some tobacco-related litigation are significant and, in certain cases range into the billions of dollars. We anticipate that new
cases will continue to be filed. The FCTC encourages litigation against tobacco product manufacturers. It is possible that our results of operations, cash
flows or financial position could be materially affected by an unfavorable outcome or settlement of litigation.
Cigarettes are subject to substantial taxes. Significant increases in cigarette-related taxes have been proposed or enacted and are likely to continue to
be proposed or enacted in numerous jurisdictions. These tax increases may affect our sales and profitability and make us less competitive versus
certain of our competitors.
Tax regimes, including excise taxes, sales taxes and import duties, can disproportionately affect the retail price of manufactured cigarettes versus
other tobacco products, or disproportionately affect the relative retail price of our RED SUN and MAGIC cigarettes and, upon FDA authorization, our
BRAND A and BRAND B cigarettes versus lower-priced cigarette brands manufactured by our competitors. Increases in cigarette taxes are expected to
continue to have an adverse impact on sales of cigarettes resulting in (i) lower consumption levels, (ii) a shift in sales from manufactured cigarettes to other
tobacco products or to lower-price cigarette categories, (iii) a shift from local sales to legal cross-border purchases of lower price products, and (iv) illicit
products such as contraband and counterfeit.
We may become subject to governmental investigations on a range of matters.
Tobacco companies are often subject to investigations, including allegations of contraband shipments of cigarettes, allegations of unlawful pricing
activities within certain markets, allegations of underpayment of custom duties and/or excise taxes, and allegations of false and misleading usage of
descriptors such as “lights” and “ultra-lights.” We cannot predict the outcome of any to which we may become subject, and we may be materially affected
by an unfavorable outcome of future investigations.
Risks Related to Intellectual Property
Our proprietary rights may not adequately protect our intellectual property, products and potential products, and if we cannot obtain adequate
protection of our intellectual property, products and potential products, we may not be able to successfully market our products and potential products.
Our commercial success will depend in part on obtaining and maintaining intellectual property protection for our technologies, products and
potential products. We will only be able to protect our technologies, products and potential products from unauthorized use by third parties to the extent
that valid and enforceable patents cover them, or other market exclusionary rights apply.
24
The patent positions of life sciences companies, like ours, can be highly uncertain and involve complex legal and factual
questions for which important legal principles remain unresolved. No consistent policy regarding the breadth of claims allowed in such
companies’ patents has emerged to date in the United States. The general patent environment outside the United States also involves
significant uncertainty. Accordingly, we cannot predict the breadth of claims that may be allowed or that the scope of these patent rights
could provide a sufficient degree of future protection that could permit us to gain or keep our competitive advantage with respect to these
products and technology. Additionally, life science companies like ours are often dependent on creating a pipeline of products. We may
not be able to develop additional potential products or proprietary technologies that produce commercially viable products or that are
themselves patentable.
Although there are currently no challenges to any portion of our intellectual property, our issued patents may be subject to
challenge and possibly invalidated by third parties. Changes in either the patent laws or in the interpretations of patent laws in the United
States or other countries may diminish the value of our intellectual property. In addition, others may independently develop similar or
alternative products and technologies that may be outside the scope of our intellectual property. Should third parties obtain patent rights to
similar products or technology, this may have an adverse effect on our business.
We also rely on trade secrets to protect our technology, products and potential products, especially where we do not believe
patent protection is appropriate or obtainable. Trade secrets, however, are difficult to protect. While we believe that we use reasonable
efforts to protect our trade secrets, our own, our licensees’ or our strategic partners’ employees, consultants, contractors or advisors may
unintentionally or willfully disclose our information to competitors. We seek to protect this information, in part, through the use of non-
disclosure and confidentiality agreements with employees, consultants, advisors and others. These agreements may be breached, and we
may not have adequate remedies for a breach. In addition, we cannot ensure that those agreements will provide adequate protection for
our trade secrets, know-how or other proprietary information or prevent their unauthorized use or disclosure.
To the extent that consultants or key employees apply technological information independently developed by them or by others
to our products and potential products, disputes may arise as to the proprietary rights of the information, which may not be resolved in our
favor. Key employees are required to assign all intellectual property rights in their discoveries to us. However, these key employees may
terminate their relationship with us, and we cannot preclude them indefinitely from dealing with our competitors. If our trade secrets
become known to competitors with greater experience and financial resources, the competitors may copy or use our trade secrets and
other proprietary information in the advancement of their products, methods or technologies. If we were to prosecute a claim that a third
party had illegally obtained and was using our trade secrets, it could be expensive and time consuming and the outcome could be
unpredictable. In addition, courts outside the United States are sometimes less willing to protect trade secrets than courts in the United
States. Moreover, if our competitors independently develop equivalent knowledge, we would lack any contractual claim to this
information, and our business could be harmed.
The ability to commercialize our potential products will depend on our ability to sell such products without infringing the patent or
proprietary rights of third parties. If we are sued for infringing intellectual property rights of third parties, such litigation could be
costly and time consuming and an unfavorable outcome could have a significant adverse effect on our business.
The ability to commercialize our potential products will depend on our ability to sell such products without infringing the patents
or other proprietary rights of third parties. Third-party intellectual property rights in our field are complicated, and third-party intellectual
property rights in these fields are continuously evolving. While we have conducted searches for such third-party intellectual property
rights, we have not performed specific searches for third-party intellectual property rights that may raise freedom-to-operate issues, and
we have not obtained legal opinions regarding commercialization of our potential products. As such, there may be existing patents that
may affect our ability to commercialize our potential products.
In addition, because patent applications are published up to 18 months after their filing, and because patent applications can take
several years to issue, there may be currently pending third-party patent applications and freedom-to-operate issues that are unknown to
us, which may later result in issued patents.
If a third-party claims that we infringe on its patents or other proprietary rights, we could face a number of issues that could
seriously harm our competitive position, including:
•
infringement claims that, with or without merit, can be costly and time consuming to litigate, can delay the regulatory
approval process and can divert management’s attention from our core business strategy;
• substantial damages for past infringement which we may have to pay if a court determines that our products or technologies
infringe upon a competitor’s patent or other proprietary rights;
25
• a court order prohibiting us from commercializing our potential products or technologies unless the holder licenses the patent
•
•
or other proprietary rights to us, which such holder is not required to do;
if a license is available from a holder, we may have to pay substantial royalties or grant cross licenses to our patents or other
proprietary rights; and
redesigning our process so that it does not infringe the third-party intellectual property, which may not be possible, or which
may require substantial time and expense including delays in bringing our potential products to market.
Such actions could harm our competitive position and our ability to generate revenue and could result in increased costs.
Our patent applications may not result in issued patents, which may have a material adverse effect on our ability to prevent others
from commercially exploiting products similar to ours.
We own or exclusively control 128 issued patents plus and additional 52 pending patent application. The patents owned by or
exclusively licensed to us include patents issued in 96 countries. We cannot assure you these patent applications will issue, in whole or in
part, as patents. Patent applications in the United States are maintained in secrecy until the patents are published or are issued. Since
publication of discoveries in the scientific or patent literature tends to lag behind actual discoveries by several months, we cannot be
certain that we are the first creator of inventions covered by pending patent applications or the first to file patent applications on these
inventions. We also cannot be certain that our pending patent applications will result in issued patents or that any of our issued patents
will afford protection against a competitor. In addition, patent applications filed in foreign countries are subject to laws, rules and
procedures that differ from those of the United States, and thus we cannot be certain that foreign patent applications related to U.S.
patents will be issued. Furthermore, if these patent applications issue, some foreign countries provide significantly less effective patent
enforcement than in the United States.
The status of patents involves complex legal and factual questions and the breadth of claims allowed is uncertain. Accordingly,
we cannot be certain that the patent applications that we or our licensors file will result in patents being issued, or that our patents and any
patents that may be issued to us in the near future will afford protection against competitors with similar technology. In addition, patents
issued to us may be infringed upon or designed around by others and others may obtain patents that we need to license or design around,
either of which would increase costs and may adversely affect our operations.
We license certain patent rights from third-party owners. If such owners do not properly maintain or enforce the patents underlying
such licenses, our competitive position and business prospects could be harmed.
We license rights to third-party intellectual property that is necessary or useful for our business, and we may enter into additional
licensing agreements in the future. Our success could depend in part on the ability of some of our licensors to obtain, maintain and
enforce patent protection for their intellectual property, in particular, those patents to which we have secured exclusive rights. Our
licensors may not successfully prosecute the patent applications to which we are licensed. Even if patents are issued with respect to these
patent applications, our licensors may fail to maintain these patents, may determine not to pursue litigation against other companies that
are infringing these patents, or may pursue such litigation less aggressively than we could. Without protection for the intellectual property
we license, other companies might be able to offer substantially identical products for sale, which could adversely affect our competitive
business position and harm our business prospects.
Our two worldwide exclusive licenses relating to tobacco, one from NCSU and the other from National Research Council of
Canada, Plant Biotechnology Institute (“NRC”), each involve multiple patent families. The exclusive rights under the NCSU agreement
expires on the date on which the last patent or registered plant variety covered by the subject license expires in the country or countries
where such patents or registered plant varieties are in effect. The NCSU license relates predominately to issued patents, and our exclusive
rights in the NCSU license will expire in 2023. The exclusive rights granted to us under the NRC agreement would have expired on the
date on which the last patent covered by the subject license expires in the country or countries where such patents are in effect. The NRC
license related to issued patents and patent applications, and our exclusive rights in the NRC license was previously scheduled to expire in
2028. On December 23, 2014, we purchased from NRC all the issued patents and patent applications that were exclusively licensed to us
by NRC.
Our worldwide sublicense from Anandia, a plant biotechnology company based in Vancouver, Canada, grants us exclusive rights
in the United States and co-exclusive rights with Anandia everywhere else in the world (except not in Canada where Anandia retains
exclusive rights) to 23 patent applications relating to four genes in the cannabis plant that are required for the production of cannabinoids,
the active ingredients in the cannabis plant. The Anandia sublicense continues through the life of the last-to-expire patent, which is
expected to be in 2035.
26
Risks Related to Ownership of Our Common Stock
An active trading market for our common stock may not be sustained, and you may not be able to resell your shares at or above the
price at which you purchased them.
An active trading market for our shares may not be sustained. In the absence of an active trading market for our common stock,
shares of common stock may not be able to be resold at or above the purchase price of such shares. Although there can be no assurances,
we expect that our common stock will continue to be quoted on the New York Stock Exchange MKT (NYSE MKT) on which the shares
of our common stock are currently quoted. However, even if our common stock continues to be quoted on the NYSE MKT, there is no
assurance that an active market for our common stock will continue in the foreseeable future. There also can be no assurance that we can
maintain such listing on the NYSE MKT. It may be more difficult to dispose of shares or obtain accurate quotations as to the market value
of our common stock compared to securities of companies whose shares are traded on national stock exchanges.
Our stock price may be highly volatile and could decline in value.
Our common stock is currently traded on the NYSE MKT and the market prices for our common stock have been volatile.
Further, the market prices for securities in general have been highly volatile and may continue to be highly volatile in the future. The
following factors, in addition to other risk factors described in this section, may have a significant impact on the market price of our
common stock:
• results from and any delays in any clinical trials programs;
• failure or delays in entering potential products into clinical trials;
• failure or discontinuation of any of our research programs;
• delays in establishing new strategic relationships;
• delays in the development of our potential products and commercialization of our potential products;
• market conditions in our sector and issuance of new or changed securities analysts’ reports or recommendations;
• general economic conditions, including recent adverse changes in the global financial markets;
• actual and anticipated fluctuations in our quarterly financial and operating results;
• developments or disputes concerning our intellectual property or other proprietary rights;
• introduction of technological innovations or new commercial products by us or our competitors;
• issues in manufacturing or distributing our products or potential products;
• market acceptance of our products or potential products;
• third-party healthcare reimbursement policies;
• FDA or other United States or foreign regulatory actions affecting us or our industry;
• litigation or public concern about the safety of our products or potential products;
• additions or departures of key personnel;
• third-party sales of large blocks of our common stock;
• sales of our common stock by our executive officers, directors or significant stockholders; and
• equity sales by us of our common stock or securities convertible into common stock to fund our operations.
These and other external factors may cause the market price and demand for our common stock to fluctuate substantially, which
may limit or prevent investors from readily selling their shares of common stock and may otherwise negatively affect the liquidity of our
common stock. In addition, in the past, when the market price of a stock has been volatile, holders of that stock have instituted securities
class action litigation against the company that issued the stock. If any of our stockholders brought a lawsuit against us, we could incur
substantial costs defending the lawsuit. Such a lawsuit could also divert the time and attention of our management.
Future sales of our common stock will result in dilution to our common stockholders.
Sales of a substantial number of shares of our common stock in the public market may depress the prevailing market price for
our common stock and could impair our ability to raise capital through the future sale of our equity securities. Additionally, if the holders
of outstanding options or warrants exercise or convert those shares, as applicable, our common stockholders will incur dilution in their
relative percentage ownership. The prospect of this possible dilution may also impact the price of our common stock.
27
We are controlled by our current officers and directors.
As of February 3, 2015, our directors and executive officers as a group beneficially owned approximately 24.6% of our common
stock. Accordingly, our directors and executive officers will have substantial influence over, and may have the ability to control, the
election of our board of directors and the outcome of issues submitted to a vote of our stockholders.
We do not expect to declare any dividends on our common stock in the foreseeable future.
We have not paid cash dividends to date on our common stock. We currently intend to retain our future earnings, if any, to fund
the development and growth of our business, and we do not anticipate paying any cash dividends on our common stock for the
foreseeable future. Additionally, the terms of any future debt facilities may preclude us from paying dividends on the common stock. As a
result, capital appreciation, if any, of our common stock could be the sole source of gain for the foreseeable future.
Anti-takeover provisions contained in our articles of incorporation and bylaws, as well as provisions of Nevada law, could impair a
takeover attempt.
Our amended and restated articles of incorporation and bylaws currently contain provisions that, together with Nevada law,
could have the effect of rendering more difficult or discouraging an acquisition deemed undesirable by our board of directors. Our
corporate governance documents presently include the following provisions:
•
•
•
providing for a “staggered” board of directors in which only one-third (1/3) of the directors can be elected in any year;
authorizing blank check preferred stock, which could be issued with voting, liquidation, dividend and other rights superior to our
common stock; and
limiting the liability of, and providing indemnifications to, our directors and officers.
These provisions, alone or together, could delay hostile takeovers and changes in control of us or changes in our management.
As a Nevada corporation, we also may become subject to the provisions of Nevada Revised Statutes Sections 78.378 through
78.3793, which prohibit an acquirer, under certain circumstances, from voting shares of a corporation’s stock after crossing specific
threshold ownership percentages, unless the acquirer obtains the approval of the stockholders of the issuer corporation. The first such
threshold is the acquisition of at least one-fifth, but less than one-third of the outstanding voting power of the issuer. We may become
subject to the above referenced Statutes if we have 200 or more stockholders of record, at least 100 of whom are residents of the State of
Nevada, and do business in the State of Nevada directly or through an affiliated corporation.
As a Nevada corporation, we are subject to the provisions of Nevada Revised Statutes Sections 78.411 through 78.444, which
prohibit an “interested stockholder” from entering into a combination with the corporation, unless certain conditions are met. An
“interested stockholder” is a person who, together with affiliates and associates, beneficially owns (or within the prior two years did own)
10 percent or more of the corporation’s voting stock.
Any provision of our amended and restated articles of incorporation, our bylaws or Nevada law that has the effect of delaying or
deterring a change in control of our Company could limit the opportunity for our stockholders to receive a premium for their shares of our
common stock, and could also affect the price that some investors are willing to pay for our common stock.
28
Item 1B
Unresolved Staff Comments.
None.
Item 2.
Properties.
Our principal administrative offices are located in Clarence, New York. We currently lease 3,800 square feet of office space. The
lease expires August 31, 2015, after which we have two (2) additional lease renewal option periods of one (1) year each. Scheduled rent
remaining as of December 31, 2014 is $28,840 for 2015.
We have a lease for our warehouse and cigarette manufacturing facility located in North Carolina. The lease commenced on
January 14, 2014, and has an initial term of twelve (12) months (the “Initial Term”). The lease contains four (4) additional extensions; one
for an additional one (1) year and three for an additional two (2) years in duration, exercisable at the option of NASCO. The lease calls for
minimum lease payments of $96,000 during the Initial Term, $123,000 for the one (1) year optional extension, $144,525 and $153,750 for
each year of the first two (2) year optional extensions, and $169,125 for each year of the final two (2) year optional extensions.
Item 3.
Legal Proceedings.
From time to time we may be involved in claims arising in the ordinary course of business. To our knowledge, no legal
proceedings, governmental actions, investigations or claims are currently pending against us or involve us that, in the opinion of our
management, could reasonably be expected to have a material adverse effect on our business and financial condition.
Item 4.
Mine Safety Disclosures.
Not applicable
PART II
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Our common stock is quoted on the NYSE MKT under the symbol “XXII.” As of February 4, 2015, there were 89 holders of
record of shares of our common stock. The following table sets forth, for the quarters indicated, the high and low bid prices per share of
our common stock, as derived from quotations provided by (i) the OTC Bulletin Board Information Center for the period prior to March
11, 2014, when our common stock was quoted on the OTC Bulletin Board, and (ii) the NYSE MKT for the period beginning on March
11, 2014, when our common stock commenced being listed and quoted on the NYSE MKT.
Quarter Ended
High Bid
Low Bid
December 31, 2014
September 30, 2014
June 30, 2014
March 31, 2014
December 31, 2013
September 30, 2013
June 30, 2013
March 31, 2013
Dividend Policy
$
$
$
$
$
$
$
$
2.67 $
3.35 $
3.87 $
6.36 $
2.19 $
1.74 $
0.90 $
1.07 $
1.50
1.90
2.14
1.75
0.87
0.70
0.46
0.51
We have not previously and do not plan to declare or pay any dividends on our common stock. Our current policy is to retain all
funds and any earnings for use in the operation and expansion of our business. Payment of future dividends, if any, will be at the
discretion of our board of directors after taking into account various factors, including current financial condition, operating results and
current and anticipated cash needs.
Recent issuances of Unregistered Securities
None.
29
Shares authorized for issuance under equity compensation plans
On October 21, 2010, the Company established the 2010 Equity Incentive Plan, or EIP, for officers, employees, directors,
consultants and advisors to the Company and its affiliates, consisting of 4,250,000 shares of common stock. The EIP authorized the grant
of incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock, restricted stock units, performance
shares, restricted stock and restricted stock units. There are no awards remaining to be issued from the EIP at December 31, 2014.
On April 12, 2014, the stockholders of the Company approved the 22nd Century Group, Inc. 2014 Omnibus Incentive Plan (the
“OIP”). The OIP allows for the granting of equity and cash incentive awards to eligible individuals over the life of the OIP, including the
issuance of up to 5,000,000 shares of the Company’s common stock pursuant to awards under the OIP. The OIP has a term of ten years
and is administered by the Compensation Committee of our Board of Directors to determine the various types of incentive awards that
may be granted to recipients under this plan and the number of shares of common stock to underlie each such award under the OIP.
The following table summarizes the number of stock options and shares of restricted stock granted, net of forfeitures and sales,
the weighted-average exercise price of such stock options and the number of securities remaining to be issued under all outstanding equity
compensation plans as of December 31, 2014:
Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights
(a)
Weighted-average
exercise price of
outstanding options,
warrants and rights
(b)
Number of securities
remaining available for
issuance under equity
compensation plans
(excluding securities
reflected in column (a))
(c)
Equity compensation plans approved by security holders
1,804,000(1) $
1.38(2)
4,852,444
Equity compensation plans not approved by security
holders
0
N/A
Total
1,804,000
(1)
Includes 911,000 restricted stock awards that are issued but not vested as of December 31, 2014.
0
4,852,444
(2) Weighted average exercise price only applies to the 890,000 shares issuable upon exercise of outstanding stock options.
Item 6.
Selected Financial Data.
This item is not applicable to us as a smaller reporting company.
30
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. 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 “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 specializing in technology that allows for the level of nicotine and other nicotinic
alkaloids (e.g., nornicotine, anatabine and anabasine) in tobacco plants to be decreased or increased through genetic engineering and plant
breeding. We focused on tobacco harm reduction and smoking cessation products. We own or exclusively control 128 issued patents plus
an additional 52 pending patent applications. The patents owned by or exclusively licensed to us include patents issued in 96 countries.
Our long-term focus is the research, development, licensing, manufacturing, and selling of our products to reduce the harm
caused by smoking. Annual worldwide tobacco product sales, cigarettes and smokeless products, are approximately $800 billion and most
of which are cigarette sales according to Euromonitor International.
•
•
•
•
•
•
•
•
•
The international licensing of our technology, proprietary tobaccos, trademarks;
The international sale of our branded proprietary tobaccos;
The manufacture, marketing and distribution of RED SUN and MAGIC proprietary cigarettes;
The production of SPECTRUM research cigarettes for NIDA, a part of NIH;
The research and development of potentially less harmful or modified risk tobacco products and novel tobacco plant varieties;
The development of X-22, a prescription-based smoking cessation aid consisting of VLN cigarettes;
The pursuit of necessary regulatory approvals and clearances from the FDA to market in the U.S. X-22 as a prescription
smoking cessation aid and BRAND A and BRAND B as reduced-risk or Modified Risk Cigarettes;
The contract manufacturing of third-party branded tobacco products; and
The research and development in Canada of unique plant varieties of hemp/cannabis, such as (i) plants with low to no amounts
of delta-9-tetrahydrocannabinol, or THC, for the legal hemp industry, (ii) plants with high levels of THC for the legal
recreational cannabis market, and (iii) plants with high levels of cannabidiol, or CBD, and other non-THC cannabinoids for the
legal medical marijuana markets.
31
We believe our proprietary technology, tobaccos and products can generate multiple significant revenue streams from licensing
of our technology and tobacco and from the sales of our products.
As previously reported, on October 25, 2014, our Board of Directors terminated the employment of Joseph Pandolfino, our
former Chief Executive Officer, pursuant to Section 4.2 (Termination Without Cause) of Mr. Pandolfino's Employment Agreement and
formed an Executive Committee of the Board, consisting of the existing independent directors, to assist our management until the Board
completes its search for and selection of a new Chief Executive Officer. Although Mr. Pandolfino will not be re-joining us as an employee
or officer, he remains a member of the Board of Directors.
Since October 2014, the Executive Committee has been primarily working with management to assist it with forming the proper
strategic direction of our business and to streamline and organize our business in light of the termination of Mr. Pandolfino. The
Executive Committee expects to hire a third party advisory firm during the first quarter of 2015 in order to assist with the search for and
selection of a new Chief Executive Officer.
Please refer to the “Business” section in this Annual Report on Form 10-K for additional information regarding our business and
operations.
Results of Operations
Year Ended December 31, 2014 Compared to Year Ended December 31, 2013
Revenue - Royalties from licensing.
In the year ended December 31, 2014, we realized no licensing revenue. During the year ended December 31, 2013 we realized
royalty revenue of $7.0 million from the worldwide Research License and Commercial Option Agreement entered into with BAT.
Revenue - Sale of products.
We realized revenue of $528,991 from the sale of products during the year ended December 31, 2014, as compared to revenue of
$278,383 during the year ended December 31, 2013, an increase of $250,608 or 90%. The revenue of $528,991 for the year ended
December 31, 2014, consisted of $447,535 in revenue derived from the sale of 5.5 million SPECTRUM research cigarettes during January
2014 and from the production of filtered cigars in our North Carolina manufacturing facility in the amount of $81,456. The revenue for
the year ended December 31, 2013, was derived from the sale of our proprietary VLN tobacco to a customer in the Netherlands in the
amount of $52,500 and from the sale of our VLN tobacco to the FDA as a subcontractor under a government contract between RTI and
the FDA in the amount of $225,883.
Costs of goods sold - Royalties for licensing.
During the year ended December 31, 2014, we revised the estimate of the royalty fee due to NRC in connection with the
$7,000,000 fee received from BAT in the fourth quarter of 2013. The new amount due to NRC of $660,000 exceeded the estimate of
$413,566, originally recorded in the year ended December 31, 2013, by $246,434.
Costs of goods sold - Products.
In the year ended December 31, 2014, costs of goods sold were $252,002 or 47.6% of revenue. The cost of goods sold consists of
$177,696 relating to the production of the SPECTRUM research cigarettes and $74,306 relating to the manufacture of the filtered cigars.
In the year ended December 31, 2013, the cost of goods sold were $48,105 or 17.3% of revenue.
Research and development expense.
Research and development expense was $1,249,007 for the year ended December 31, 2014, an increase of $504,777, or 67.8%,
from $744,230 for the year ended December 31, 2013. This increase was primarily the result of increases in stock based compensation of
approximately $220,000, research and development payroll and related benefits of approximately $104,000, royalty and license fees of
approximately $187,000, and $15,000 of costs associated with an FDA modified-risk application, partially offset by a decrease in
contractual research and development costs of approximately $39,000 during the year ended December 31, 2014 as compared to the year
ended December 31, 2013.
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General and administrative expense.
General and administrative expense was $8,793,151 in the year ended December 31, 2014, an increase of $4,686,457, or 114.1%,
from $4,106,694 in the year ended December 31, 2013. The increase was primarily due to increases in employee stock based
compensation of approximately $1,047,000, employee related costs of approximately $693,000, legal and professional fees of
approximately $986,000, costs relating to press releases of approximately $78,000, the write off of an uncollectible advance in the
approximate amount of $43,000, NYSE MKT related costs of approximately $176,000, costs associated with severance liability of
approximately $637,000, director fee costs of approximately $157,000, the expense associated with the Crede consulting agreement in the
approximate amount of $2,091,000, and other administrative costs of approximately $171,000, partially offset by decreases in stock based
compensation and cash payments to third-party service providers of approximately $1,318,000 and $75,000, respectively, during the year
ended December 31, 2014 as compared to the year ended December 31, 2013.
Pre-manufacturing facility costs.
On August 29, 2014, we completed the transaction to purchase all of the issued and outstanding membership interests of
NASCO. The purchase transaction was subject to various conditions, including the required consents of the 46 Settling States of the MSA
to an amendment of NASCO’s existing adherence agreement to the MSA, with the Company becoming a signatory to such amended
adherence agreement as part of our acquisition of NASCO. On August 29, 2014, the Company became a signatory to the amended
adherence agreement. NASCO operates our cigarette manufacturing facility in North Carolina. Prior to the closing of our acquisition of
NASCO, the factory was primarily in a pre-manufacturing stage, incurring various expenses relating to preparing and upgrading the
warehouse and manufacturing facility for production. Those expenses included salaries and benefits for employees, sub-contract labor,
rent, utilities and other miscellaneous costs and amounted to $1,176,676 during the year ended December 31, 2014. There were no
expenses relating to the cigarette manufacturing facility during the year ended December 31, 2013. We manufactured a modest quantity
of filtered cigars during the year ended December 31, 2014 generating revenue in the amount of $81,456. We also commenced
manufacturing our proprietary cigarette brands and an MSA brand for a chain of independent smokeshops during the fourth quarter of
2014. Sales of these brands commenced during the first quarter of 2015. NASCO will also continue to manufacture non-MSA filtered
cigars.
Sales and marketing costs.
Sales and marketing costs were $85,930 for the year ended December 31, 2014, an increase of $76,878, or 849.3%, from $9,052
for the year ended December 31, 2013. The increase is primarily the result of costs associated with participation in tobacco industry trade
shows, RED SUN packaging design costs, and materials used for marketing trips to Europe and Asia.
Amortization and depreciation expense.
Amortization and depreciation expense for the year ended December 31, 2014 amounted to $462,772, an increase of $318,483 or
220.7% from $144,289 for the year ended December 31, 2013. Amortization expense relates to amortization taken on capitalized patent
costs. Amortization expense for the year ended December 31, 2014 was $232,760 an increase of $91,499 or 64.8% from $141,261 for the
year ended December 31, 2013. The increase is primarily due to an adjustment to the 2013 amortization that was recorded in the first
quarter of 2014 and by amortization on additional investments in patents during the years ended December 31, 2014 and 2013 in the
amount of $641,866 and $332,826, respectively, partially offset by a change in the estimated useful lives of one of the patent families
during the year ended December 31, 2013. Depreciation expense for the year ended December 31, 2014 was $230,012, an increase of
$226,984 from $3,028 for the year ended December 31, 2013. This increase is mainly due to approximately $2.9 million of cigarette
manufacturing equipment placed in service during the second quarter of 2014.
33
Warrant liability loss - net.
The warrant liability loss of $3,676,691 for the year ended December 31, 2014 was due to an increase in the warrants liability
recorded in the first quarter of 2014 in the amount of $3,841,943 in conjunction with the Warrant Amendment program offset by a
decrease in the estimated fair value of the warrants during the year in the amount of $165,252, primarily attributable to the decrease in the
Company’s underlying stock price from $2.14 per share at December 31, 2013, as compared to $1.65 per share at December 31, 2014.
In a private placement in the first quarter of 2013, we issued warrants which were accounted for as derivatives and upon
issuance a liability at the estimated fair value was recorded. At the date of issuance of these warrants, the value exceeded that total
consideration received by an aggregate of $3,987,655 resulting in an immediate charge to expense for this amount. In connection with the
exercise of 1,101,034 Series B Warrants in July 2013, we issued a like number of Series C Warrants which were accounted for as
derivatives and upon issuance a liability at the estimated fair value was recorded. At the date of issuance of these warrants, the value was
estimated to be $1,622,069 which exceeded the sum of the net proceeds received in the exercise and the reclassification of warrant
liability to capital by $343,079 resulting in an immediate charge to expense for this amount. These two charges added to the loss on
warrant liability of $19,271,977, resulting from an increase in the fair value during the year ended December 31, 2013 for all warrants we
have issued, resulting in a total loss on warrant liability-derivative for the year of $23,602,711. The loss on warrant liability of
$19,271,977 was primarily the result of an increase in the Company’s underlying stock price from $0.75 per share at December 31, 2012,
as compared to $2.14 per share at December 31, 2013.
Future periods will reflect a gain or loss based on the change in the fair value of the derivatives, which is based on a number of
factors including the Company’s stock price.
Loss on equity investment.
The loss on equity investment of $101,165 for the year ended December 31, 2014, consists of (i) our 25% share of Anandia’s net
loss from our initial April 11, 2014 investment in Anandia through December 31, 2014 in the amount of $84,350, plus (ii) amortization of
the intangible asset represented by the difference between our equity investment in Anandia and our portion of the book value of the net
assets of Anandia in the amount of $16,815.
Interest expense and amortization of debt discount and expense.
Interest expense and amortization of debt discount and debt issuance costs decreased during the year ended December 31, 2014
to $7,094 from $748,605 during the year ended December 31, 2013. This decrease of $741,511 or 99.1% was primarily the result of a
decrease in the amortization of debt discount and debt issuance costs relating to convertible notes issued on August 9, 2012 that were
converted into common stock in August of 2013, payment of the majority of the Company’s interest bearing debt in the fourth quarter of
2013, and the recording as interest expense the excess of the fair value of warrants issued during the year ended December 31, 2013 over
the proceeds realized in the amount of approximately $509,000. The Company’s demand bank loan is the only remaining interest bearing
debt outstanding at December 31, 2014.
Net loss.
We had a net loss for the year ended December 31, 2014 of $15,595,358 as compared to a net loss of $26,153,158 for the year
ended December 31, 2013. The decrease in the net loss of $10,557,800 or 40.4%, was primarily the result of a decrease in the warrant
liability loss - net in the amount of $19,926,020, a decrease in interest expense and amortization of debt discount in the amount of
$741,511, a decrease in the warrant amendment inducement expense of $3,591,765 and an increase in the gain on the sale of machinery
and equipment of $71,121, offset by a decrease in gross profit of $6,786,157, an increase in operating expenses of $6,763,271, and a
decrease in other income of $206,374.
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Liquidity and Capital Resources
Working Capital
As of December 31, 2014, we had working capital of approximately $8.0 million, as compared to working capital of approximately $6.8 million
at December 31, 2013, an increase of approximately $1.2 million. The $1.2 million increase in working capital was primarily the result of net working
capital remaining from the net proceeds of the $9.3 million raised in the September 2014 common stock private placement after operating and investing
activities during the year ended December 31, 2014.
We must successfully execute our business plan to increase revenue in order to achieve positive cash flows to sustain adequate liquidity without
requiring additional funds from external sources to meet minimum operating requirements. The Company’s Form S-3 universal shelf registration statement
was filed with the U.S. Securities and Exchange Commission (“SEC”) on April 18, 2014, and became effective on June 5, 2014. The universal shelf
registration statement will allow, but not compel, the Company to raise up to $45 million of capital over a three-year period through a wide array of
securities at times and in amounts to be determined by the Company. There can be no assurance that additional capital, if required, will be available on
acceptable terms or at all.
Cash demands on operations
In 2014, we had an operating loss of approximately $11.7 million and used cash in operations of approximately $6.6 million during the year
ended December 31, 2014. Excluding contract growing of our proprietary tobacco with farmers, extraordinary expenses such as potential clinical trials,
capital expenses for our factory, and initial expenses associated with the launch of our RED SUN cigarette brand, our monthly cash expenditures are
approximately $500,000. We believe that cash on hand at December 31, 2014 of $6,402,687 is adequate to sustain operations and meet all current
obligations as they come due for a period of approximately 12 months.
Net Cash (used in) provided by Operating Activities
In the year ended December 31, 2014, $6,582,730 of cash was used operating activities compared to $3,855,834 of cash provided by operating
activities in the year ended December 31, 2013, a decrease of $10,438,564. This decrease in cash provided by operations was mainly due to the license
revenue received from BAT under the Research License and Commercial Option Agreement in the amount of $7,000,000 in 2013 as compared to no
revenue from licensing in 2014. In addition, approximately $3,400,000 in additional cash was consumed in operating activities.
Net Cash used in Investing Activities
In the year ended December 31, 2014, we used $2,707,992, as compared to $3,742,789 of cash used in investing activities during the year ended
December 31, 2013, a decrease of $984,797. The decrease in cash used in investing activities is primarily due to a decrease in the acquisition of machinery
and equipment in the amount of $3,239,966, and an increase in proceeds received on the sale of machinery and equipment in the amount of $631,484,
offset by increases in the acquisition of patents and trademarks of $436,653, license fees of $1,450,000, the cash portion of the equity investment in
Anandia of $700,000, and the cash portion of the NASCO transaction of $250,000.
Net Cash from Financing Activities
During the year ended December 31, 2014, we generated $9,862,810 from our financing activities, as compared to $5,717,366 of cash generated
from financing activities during the year ended December 31, 2013, an increase of $4,145,444. The $9,862,810 generated during the year ended December
31, 2014 was mainly the a result of net cash proceeds received from a common stock private placement in September 2014, in the amount of $9,324,088,
and net cash proceeds from the exercise of stock warrants and stock options in the amount of $535,251. The $5,717,366 of cash generated during the year
ended December 31, 2013 was primarily the result of the net proceeds from the Series A-1 Preferred stock placement in the amount of $2,034,664, net
cash proceeds received from the exercise of warrants in the amount of $2,254,999, proceeds received from the issuance of notes payable in the amount of
$150,000, proceeds received from the exercise of stock options in the amount of $5,200, and net cash proceeds received from the Warrant Exchange
Program in the amount of $3,239,385. These proceeds raised were partially offset by payments on notes payable, convertible notes payable and net
payments to related parties and officers in the amount of $1,620,299, $339,250 and $8,993, respectively.
Critical Accounting Policies and Estimates
Accounting principles generally accepted in the United States of America, or U.S. GAAP, require estimates and assumptions to be made that
affect the reported amounts in our consolidated financial statements and accompanying notes. Some of these estimates require difficult, subjective and/or
complex judgments about matters that are inherently uncertain and, as a result, actual results could differ from those estimates. Due to the estimation
processes involved, the following summarized accounting policies and their application are considered to be critical to understanding our business
operations, financial condition and results of operations.
35
Revenue Recognition
We recognize revenue at the point the product is shipped to a customer and title has transferred. Revenue from the sale of our
products is recognized net of cash discounts, sales returns and allowances. Federal cigarette excise taxes are included in net sales and
accounts receivable billed to customers, except on sales of SPECTRUM and exported cigarettes in which such taxes do not apply.
We were chosen to be a subcontractor for a government contract between RTI International (“RTI”) and NIDA to supply
research cigarettes to NIDA. These government research cigarettes are distributed under the Company’s mark SPECTRUM. Future
revenue under this arrangement is expected to be related to the delivery of SPECTRUM and will be recognized at the point the product is
shipped and title has transferred. In September 2013, we received a purchase order for an additional 5.5 million SPECTRUM research
cigarettes that were manufactured and shipped in January 2014. Total revenue from this order was approximately $447,535 and a down
payment on the order was received in the fourth quarter of 2013 in the amount of $179,014. The down payment has been recorded as
deferred revenue on the Company’s balance sheet at December 31, 2013. There were no SPECTRUM cigarettes delivered during the year
ended December 31, 2013.
As described above, we license our patented technology to third parties. Revenue is recognized from licensing arrangements as
contractually defined in licensing agreements. We account for milestone elements contained in licensing agreements in accordance with
ASC 605. Simultaneous with the signing of the Research License and Commercial Option Agreement, BAT paid us a non-refundable
$7,000,000. Revenue was recognized for this amount since delivery of the patented technology took place, we had no further performance
obligations, and the fee was fixed. We will be entitled to receive additional payments from BAT, up to an additional $7,000,000, during
the Research Term in the event certain milestones are met by BAT with respect to BAT’s research and development of our patent rights
licensed by the Company to BAT. There are four separate milestones, two of which BAT would pay us $2 million for each milestone
achieved, and two of which BAT would pay us $1.5 million for each milestone achieved. In addition, the Company could earn additional
future royalties if BAT elects to exercise the Commercial Option Agreement during the Research Term.
No amount related to the research milestones was recognized during 2014 or 2013. A portion of the patented technology
sublicensed to BAT was exclusively licensed to 22nd Century Ltd. by NRC. Pursuant to the terms of the license agreement with NRC,
22nd Century Ltd. was obligated to make a royalty payment to NRC from the monies received from BAT. During the quarter ended
September 30, 2014, 22nd Century Ltd. and NRC mutually agreed on a payment of $660,000 that was paid in December 2014. 22nd
Century Ltd. had previously estimated the payment to be $413,566. The difference in the amount of $246,434 has been recorded as
Royalty for licensing in the Cost of goods sold section of the Company’s Consolidated Statements of Operations for the year ended
December 31, 2014.
Impairment of Long-Lived Assets
We review the carrying value of amortizing long-lived assets whenever events or changes in circumstances indicate that the
historical cost-carrying value of an asset may no longer be appropriate. We also assess recoverability of the asset by estimating the future
undiscounted net cash flows expected to result from the asset, including eventual disposition. If the estimated future undiscounted net
cash flows are less than the carrying value of the asset, an impairment loss is recorded equal to the difference between the asset’s carrying
value and its fair value. Non-amortizing intangibles (e.g., patents and trademarks) are reviewed annually for impairment. We have not
recognized any impairment losses during the two year period ended December 31, 2014.
Amortization Estimates of Intangible Assets
We generally determine amortization based on the estimated useful lives of the assets and record amortization expense on a
straight-line method over such lives. The remaining life of the primary patent in each patent family is generally used to determine the
estimated useful life of the related patent costs.
Valuation of our Equity Securities
We use a fair-value based method to determine compensation for all arrangements under which Company employees and others
receive shares, options or warrants to purchase common shares of 22nd Century Group. Stock based compensation expense is recorded
over the requisite service period based on estimates of probability and time of achieving milestones and vesting. For accounting purposes,
the shares will be considered issued and outstanding upon vesting.
36
Income taxes
The Company recognizes deferred tax assets and liabilities for any basis differences in its assets and liabilities between tax and
GAAP reporting, and for operating loss and credit carry-forwards. In light of the Company’s history of cumulative net operating losses
and the uncertainty of their future utilization, the Company has established a valuation allowance to fully offset its net deferred tax assets
as of December 31, 2014 and 2013.
Derivative Financial Instruments
We do not use derivative instruments to hedge exposures to cash flow, market or foreign currency risks. We evaluate all of our
financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For
derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair market value
and then is revalued at each reporting date, with changes in fair value reported in the consolidated statement of operations. The
methodology for valuing our outstanding warrants classified as derivative instruments utilizes a lattice model approach which includes
probability weighted estimates of future events including volatility of our common stock. A financial asset or liability’s classification
within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement. The warrant liability is
measured at fair value using certain estimated factors such as volatility and probability which are classified within Level 3 of the
valuation hierarchy. Significant unobservable inputs are used in the fair value measurement of the Company’s derivative warrant
liabilities include volatility. Significant increases (decreases) in the volatility input would result in a significantly higher (lower) fair
value measurement. A 10% increase or decrease in the volatility factor used as of December 31, 2014 would have the impact of
increasing or decreasing the liability by approximately $22,000.
The classification of derivative instruments, including whether such instruments should be recorded as liabilities or equity, is
evaluated at the end of each reporting period. Derivative instrument liabilities are classified in the balance sheet as current or non-current
based on whether or not net-cash settlement of the derivative instrument could be required within twelve months of the balance sheet date.
Inflation
Inflation did not have a material effect on our operating results for the years ended December 31, 2014 and 2013.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements as defined by Item 303(a)(4) of Regulation S-K.
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk.
As a smaller reporting company, we are not required to present the information required by this item.
Item 8.
Financial Statements and Supplementary Data.
The required financial statements and the notes thereto are contained in a separate section of this Form 10-K Information section
beginning with the page following Item 15 (Exhibits and Financial Statement Schedules).
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None
37
Item 9A.
Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed
in its Exchange Act (defined below) reports is recorded, processed, summarized and reported within the time periods specified in the
SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including the
Company’s president and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. Management
recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of
achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls
and procedures.
Our president and chief financial officer, after evaluating the effectiveness of the Company’s “disclosure controls and
procedures” (as defined in the Securities Exchange Act of 1934 (“Exchange Act”) Rules 13a-15(e) or 15d-15(e)) as of the end of the
period covered by this annual report, has concluded that our disclosure controls and procedures were not effective and that material
weaknesses described below exist in our internal control over financial reporting based on his evaluation of these controls and procedures
as required by paragraph (b) of Exchange Act Rules 13a-15 or 15d-15.
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal
control over financial reporting is a process designed by, or under the supervision of, the president and the chief financial officer and
effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Our evaluation of internal control over financial reporting includes using the COSO framework, an integrated framework for the
evaluation of internal controls issued by the Committee of Sponsoring Organizations of the Treadway Commission in 1992, to identify
the risks and control objectives related to the evaluation of our control environment.
Based on our evaluation under the frameworks described above, our management concluded that as of December 31, 2014, that
our internal controls over financial reporting were not effective and that material weaknesses exist in our internal control over financial
reporting. The material weakness consists of controls associated with segregation of duties and controls associated with accounting for
complex and non-routine transactions relating to certain equity and derivative instruments. To address the material weakness we
performed additional analyses and other post-closing procedures to ensure that our consolidated financial statements were prepared in
accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). Notwithstanding this material
weakness, management believes that the financial statements included in this Annual Report on Form 10-K fairly present, in all material
respects, our financial condition, result of operations and cash flows for the periods presented.
Freed Maxick CPA’s, P.C., the Company’s independent registered public accounting firm, has audited the consolidated financial
statements as of and for the year ended December 31, 2014, and the effectiveness of the Company’s internal control over financial
reporting as of December 31, 2014, as stated in their reports, which are included herein.
Changes in Internal Control over Financial Reporting
There was no change in the Company’s internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) during the quarter ended December 31, 2014 that has materially affected, or is reasonably likely to materially affect, the
Company’s internal control over financial reporting.
38
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
22nd Century Group, Inc.
We have audited 22nd Century Group, Inc. and Subsidiaries (the “Company”) internal control over financial reporting as of December 31,
2014, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of
the Treadway Commission in 1992. The Company’s management is responsible for maintaining effective internal control over financial
reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying
“Management’s Annual Report on Internal Controls Over Financial Reporting”. Our responsibility is to express an opinion on the
Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial
reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial
reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal
control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting
principles. A company's internal control over financial reporting includes those policies and procedures that (a) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (b) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations
of management and directors of the company; and (c) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of
any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or procedures may deteriorate.
39
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a
reasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or
detected on a timely basis. The following material weaknesses have been identified and included in management's assessment.
Material weaknesses related to financial closing and reporting process.
The Company did not maintain a sufficient complement of qualified accounting staff resulting in ineffective controls due to a lack of
segregation of duties and a lack of secondary review. Additionally, the Company did not maintain sufficient technical resources to ensure
that the financial statements and notes to the financial statements were presented fully in accordance with GAAP and with all required
disclosures. The Company’s corporate accounting and financial reporting function is currently performed by one person on staff. That
person performs nearly all aspects of the financial reporting process, including but not limited to access to the underlying accounting
records and systems, the ability to post and record journal entries, the responsibility to perform reconciliations of account balances, as
well as the responsibility for the preparation of the financial statements.
These material weaknesses were considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2014
financial statements, and this report does not affect our report dated February 5, 2015 on those financial statements.
In our opinion, because of the effect of the material weaknesses described above on the achievement of the objectives of the control
criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2014, based on criteria
established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission in 1992.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the
consolidated balance sheets as of December 31, 2014 and 2013 and the related consolidated statements of operations, shareholders’ equity
and cash flows of the Company for the years then ended and our report dated February 5, 2015 expressed an unqualified opinion.
/s/ FREED MAXICK CPAs, P.C.
Buffalo, New York
February 5, 2015
40
Item 9B.
Other Information.
None.
Item 10.
Directors, Executive Officers and Corporate Governance.
PART III
Information concerning our executive officers, directors and corporate governance is incorporated herein by reference to our
definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year
covered by this Form 10-K with respect to its 2015 Annual Meeting of Stockholders.
Set forth below is information regarding our directors, executive officers and key personnel.
Name
Age
Position
Henry Sicignano, III
John T. Brodfuehrer
Michael R. Moynihan, Ph.D.
Thomas L. James, Esq.
Joseph Alexander Dunn, Ph.D.
James W. Cornell
Richard M. Sanders
Joseph Pandolfino
47
57
62
56
61
58
61
46
President, Chief Operating Officer and Director
Chief Financial Officer and Treasurer
Vice President of R&D
Vice President, General Counsel and Secretary
Director*
Director**
Director***
Director****
41
* Dr. Dunn is currently Associate Dean for Research and Professor of Pharmaceutical Sciences at D’Youville College of Pharmacy in
Buffalo, New York and has served in this capacity since April 1, 2010.
** Mr. Cornell is currently the President and Chief Executive Officer of Praxiis, LLC, an enterprise that provides support for clients in
organizational change, leadership development and transactional advisory services. Mr. Cornell is also the current Manager of Larkin
Center Management, LLC, a real estate development company, and has served in this capacity since October 2010.
*** Since August 2009, Mr. Sanders has served as a General Partner of Phase One Ventures, LLC, a venture capital firm which focuses
on nanotechnology and biotechnology start-up opportunities in New Mexico and surrounding states.
**** Since October 25, 2014, Mr. Pandolfino ceased serving as an employee of 22nd Century Group, Inc. and its affiliates.
Code of Ethics
In 2006, we adopted a Code of Ethics that applies to all of our employees. A copy of our Code of Ethics is available on our
website at xxiicentury.com and will be provided to any person requesting same without charge. To request a copy of our Code of Ethics,
please make a written request to our President c/o 22nd Century Group, Inc., 9530 Main Street, Clarence, New York 14031. Future
material amendments or waivers relating to the Code of Ethics will be disclosed on our website referenced in this paragraph within four
business days following the date of such amendment or waiver.
Item 11.
Executive Compensation.
Information is incorporated herein by reference to our definitive proxy statement to be filed with the Securities and Exchange
Commission within 120 days after the end of the fiscal year covered by this Form 10-K with respect to its 2015 Annual Meeting of
Stockholders .
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Information is incorporated herein by reference to our definitive proxy statement to be filed with the Securities and Exchange
Commission within 120 days after the end of the fiscal year covered by this Form 10-K with respect to its 2015 Annual Meeting of
Stockholders .
Item 13.
Certain Relationships and Related Transactions, and Director Independence.
Information is incorporated herein by reference to our definitive proxy statement to be filed with the Securities and Exchange
Commission within 120 days after the end of the fiscal year covered by this Form 10-K with respect to its 2015 Annual Meeting of
Stockholders.
Item 14.
Principal Accounting Fees and Services.
Information is incorporated herein by reference to our definitive proxy statement to be filed with the Securities and Exchange
Commission within 120 days after the end of the fiscal year covered by this Form 10-K with respect to its 2015 Annual Meeting of
Stockholders .
Item 15.
Exhibits and Financial Statement Schedules.
(a) Financial Statements
PART IV
42
22nd CENTURY GROUP, INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
Consolidated Financial Statements:
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Shareholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Page
F-2
F-3
F-4
F-5
F-6 - F-7
F-8 - F-23
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
22nd Century Group, Inc.
We have audited the accompanying consolidated balance sheets of 22nd Century Group, Inc. and Subsidiaries as of December 31, 2014
and 2013, and the related consolidated statements of operations, shareholders’ equity, and cash flows for the years then ended. These
financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of 22nd
Century Group, Inc. and Subsidiaries as of December 31, 2014 and 2013, and the results of its operations and cash flows for the years
then ended, in conformity with U.S. generally accepted accounting principles.
We have also audited, in accordance with the standards of the Public Accounting Oversight Board (United States), 22nd Century Group,
Inc. and Subsidiaries internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control -
Integrated Framework issued by Committee of Sponsoring Organizations of the Treadway Commission in 1992. Our report dated
February 5, 2015 expressed an opinion that 22nd Century Group, Inc. had not maintained effective internal control over financial
reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission in 1992.
/s/ FREED MAXICK CPAs, P.C.
Buffalo, New York
February 5, 2015
F-2
22nd CENTURY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
ASSETS
Current assets:
Cash
Due from related party
Due from officers
Inventory, net
Prepaid consulting fees
Prepaid expenses and other assets
Machinery and equipment held for resale
Total current assets
Machinery and equipment, net
Other assets:
Intangible assets, net
Equity investment
Total other assets
Total assets
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Demand bank loan
Current portion of note payable
Accounts payable
Accrued expenses
Accrued severance
Deferred revenue
Total current liabilities
Long-term portion of note payable
Long-term portion of accrued severance
Warrant liability
Total liabilities
Commitments and contingencies (Note 17)
Shareholders' equity
Capital stock authorized:
10,000,000 preferred shares, $.00001 par value
300,000,000 common shares, $.00001 par value
Capital stock issued and outstanding:
64,085,042 common shares (56,902,770 at December 31, 2013)
Capital in excess of par value
Accumulated deficit
Total shareholders' equity
$
$
$
2014
2013
$
6,402,687
46,069
-
2,064,796
1,978,785
214,469
-
10,706,806
5,830,599
42,069
7,471
1,406,280
-
-
457,696
7,744,115
2,850,615
2,997,760
7,077,759
1,318,335
8,396,094
1,544,869
-
1,544,869
21,953,515
$
12,286,744
$
174,925
320,513
884,412
1,081,545
212,012
-
2,673,407
605,217
412,308
3,042,846
6,733,778
174,925
-
54,665
575,730
-
179,014
984,334
-
-
3,779,522
4,763,856
-
-
641
70,744,190
(55,525,094)
15,219,737
569
47,452,055
(39,929,736)
7,522,888
Total liabilities and shareholders' equity
$
21,953,515
$
12,286,744
See accompany notes to consolidated financial statements.
F-3
22nd CENTURY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31,
Revenue:
Royalties from licensing
Sale of products
Cost of goods sold:
Royalties for licensing
Products
Gross profit
Operating expenses:
Research and development (including stock based compensation of $331,467 and $111,563,
respectively)
General and administrative (including stock based compensation of $4,165,078 and
$2,250,399, respectively)
Pre-manufacturing facility costs (including stock based compensation of $27,923 and $0,
respectively)
Sales and marketing costs
Amortization and depreciation
Operating (loss) income
Other income (expense):
Warrant liability loss - net
Warrant amendment inducement expense
Gain on the sale of machinery and equipment
Loss on equity investment
Income tax credit refund
Interest expense and amortization of debt discount and expense:
Related parties
Other
Net loss
Loss per common share - basic and diluted
2014
2013
$
-
528,991
528,991
246,434
252,002
498,436
7,000,000
278,383
7,278,383
413,566
48,105
461,671
30,555
6,816,712
1,249,007
744,230
8,793,151
4,106,694
1,176,676
85,930
462,772
11,767,536
-
9,052
144,289
5,004,265
(11,736,981)
1,812,447
(3,676,691)
(144,548)
71,121
(101,165)
-
-
(7,094)
(3,858,377)
(23,602,711)
(3,736,313)
-
-
122,024
(17,889)
(730,716)
(27,965,605)
(15,595,358) $
(26,153,158)
(0.26) $
(0.60)
$
$
$
Common shares used in basic earnings per share calculation
59,993,413
43,635,182
See accompany notes to consolidated financial statements.
F-4
22nd CENTURY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
Years Ended December 31, 2014 and 2013
Preferred
Shares
Outstanding
Common
Shares
Outstanding
Par value
of Preferred
Shares
Par value
of Common
Shares
Contributed
Capital
Balance at December 31, 2012
Common stock issued upon exercise of Convertible Notes
Preferred stock issued in January 2013 private placement
Conversion of preferred stock to common stock
-
-
34,286,979
$
2,406,720
2,500
416,666
(2,500)
4,166,666
Exercise of warrants
Exercise of options
Stock based compensation
Other contributed capital
Warrant exchange program
Common stock issued in payment of accrued dividends
Net loss
Balance at December 31, 2013
Stock based compensation
Warrants issued as compensation for services
Exercise of warrants
Exercise of options
Common stock issued in September 2014 private placement
Stock issued in connection with acquisition of NASCO Products, LLC
Stock issued in connection with equity investment
Other capital contribution
Warrant amendments
Net loss
Balance at December 31, 2014
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
6,820,218
20,000
2,820,000
-
5,804,368
161,153
-
56,902,770
$
1,282,768
-
1,167,737
70,000
3,871,767
640,000
150,000
-
-
-
64,085,042
$
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
$
344 $
7,645,017
$
24
4
42
(24)
(4)
(42)
68
14,097,526
-
5,200
28
2,361,934
-
1,660
58
23,340,789
(1)
Accumulated
Deficit
(13,776,578)
-
-
-
-
-
-
-
-
-
Shareholders'
Equity (Deficit)
(6,131,217)
$
-
-
-
14,097,594
5,200
2,361,962
1,660
23,340,847
-
-
(26,153,158)
(26,153,158)
$
569 $
47,452,055
$
(39,929,736)
$
7,522,888
1
-
12
1
39
6
1
-
-
-
13
2,433,240
-
1,260,000
486,939
48,299
9,324,049
1,951,994
394,499
25,200
7,367,915
-
-
-
-
-
-
-
-
-
2,433,253
1,260,000
486,951
48,300
9,324,088
1,952,000
394,500
25,200
7,367,915
-
(15,595,358)
(15,595,358)
$
641 $
70,744,190
$
(55,525,094)
15,219,737
See accompany notes to consolidated financial statements.
F-5
22nd CENTURY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
Cash flows from operating activities:
Net loss
Adjustments to reconcile net loss to cash (used in) provided by operating activities:
2014
2013
$
(15,595,358) $
(26,153,158)
Amortization and depreciation
Amortization of license fees
Amortization of debt issuance costs
Amortization of debt discount
Loss on equity investment
Gain on the sale of machinery and equipment
Interest due to debt conversion
Warrant liability loss
Warrant amendment inducement expense
Equity based employee compensation expense
Equity based payments for outside services
Severance expense
(Increase) decrease in current assets:
Inventory
Prepaid expenses and other assets
Increase (decrease) in current liabilities:
Accounts payable
Accrued interest payable to related parties
Accrued expenses
Deferred revenue
Net cash (used in) provided by operating activities
Cash flows from investing activities:
Acquisition of patents and trademarks
Acquisition machinery and equipment
Purchase of machinery and equipment held for resale
Payment of license fees
Acquisition of NASCO Products, LLC
Proceeds from the sale of machinery and equipment
Equity investment and advance
Net cash used in investing activities
Cash flows from financing activities:
Net proceeds from exercise of warrants
Net proceeds from exercise of options
Net proceeds from warrant exchange program
Proceeds from issuance of notes
Payments on borrowings - notes payable
Payments on borrowings - convertible notes
Net proceeds from September 2014 common stock private placement
Net proceeds from January 2013 preferred stock private placement
Other capital contribution
Net payments to related party
Net advances from (to) officers
Net cash provided by financing activities
Net increase in cash
Cash - beginning of period
Cash - end of period
Cash paid during the period for interest
Cash paid during the period for income taxes
462,772
32,524
-
-
101,165
(71,121)
-
3,676,691
144,548
2,293,083
2,231,385
624,320
(620,660)
(214,469)
625,389
-
(93,985)
(179,014)
(6,582,730)
(726,989)
(212,487)
-
(1,450,000)
(250,000)
631,484
(700,000)
(2,707,992)
486,951
48,300
-
-
-
-
9,324,088
-
-
(4,000)
7,471
9,862,810
572,088
5,830,599
6,402,687
7,094
-
$
$
$
144,289
-
4,232
134,296
-
-
526,448
23,602,711
3,736,313
980,162
1,381,800
(175,754)
10,044
(629,101)
(3,567)
118,105
179,014
3,855,834
(290,336)
(2,994,757)
(457,696)
-
-
-
-
(3,742,789)
2,254,999
5,200
3,239,385
150,000
(1,620,299)
(339,250)
-
2,034,664
1,660
(5,100)
(3,893)
5,717,366
5,830,411
188
5,830,599
135,247
-
$
$
$
F-6
22nd CENTURY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Years Ended December 31,
2014
2013
Supplemental disclosure of investing and financing activities
Reclassification of derivative liability to equity due to warrant amendments
Patent and trademark additions included in accounts payable
Machinery and equipment additions included in accounts payable
License fee included in accrued expenses
Equity investment included in accrued expenses
Issuance of common stock for equity investment
Issuance of common stock for acquisition of NASCO Products, LLC
Issuance of warrants as a derivative liability issued under a consulting agreement and included
in prepaid consulting fees
Warrants issued under a consulting agreement resulting in an increase in capital and included
in prepaid consulting fees
Reclassification of machinery and equipment purchases to inventory
Other capital contribution
Patent additions acquired with note payable
Accounts payable converted to promissory notes
Accrued interest converted to promissory notes
Notes payable and accrued interest converted to common shares
Common stock issued in payment of preferred stock dividend payable
Common stock issued for fees relating to January 2013 preferred stock private placement
Refinance of convertible note to note payable
Issuance of warrants as derivative liability instruments and reduction of capital
Increase in warrant liability and reduction in capital as a result of lowering the exercise price
on certain warrants
Reclassification of derivative liability to equity due to warrant exchange program
Common stock issued for fees relating to December 2013 warrant exchange program
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
7,367,915
193,454
10,904
300,000
325,000
394,500
1,952,000
$
$
$
$
$
$
$
2,810,000
$
1,260,000
37,856
25,200
925,730
-
-
-
-
-
-
-
-
-
-
$
$
$
$
$
$
$
$
$
$
$
$
$
$
14,433,178
42,490
-
-
-
-
-
-
-
-
-
-
769,377
26,422
1,650,305
93,361
416,666
57,500
5,675,634
626,328
19,639,465
462,000
See accompanying notes to consolidated financial statements.
F-7
22nd CENTURY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2014
NOTE 1. - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation - The accompanying consolidated financial statements include the accounts of 22nd Century Group,
Inc. (“22nd Century Group”), its three wholly-owned subsidiaries, 22nd Century Limited, LLC (“22nd Century Ltd”), NASCO Products,
LLC (“NASCO”), and Botanical Genetics, LLC (“Botanical Genetics”), and a 51% owned subsidiary, 22nd Century Asia Ltd. (“22nd
Century Asia”), and two wholly-owned subsidiaries of 22nd Century Ltd, Goodrich Tobacco Company, LLC (“Goodrich Tobacco”) and
Hercules Pharmaceuticals, LLC (“Hercules Pharma”) (collectively, “the Company”). All intercompany accounts and transactions have
been eliminated.
Nature of Business - 22nd Century Ltd, is a plant biotechnology company specializing in technology that allows for the level of
nicotine and other nicotinic alkaloids (e.g., nornicotine, anatabine and anabasine) in tobacco plants to be decreased or increased through
genetic engineering and plant breeding. The Company owns or exclusively controls 128 issued patents plus an additional 52 pending
patent applications. The patents owned by or exclusively licensed to us include patents issued in 96 countries. Goodrich Tobacco and
Hercules Pharma are business units for the Company’s (i) premium cigarettes and potential modified risk tobacco products and (ii)
smoking cessation product, respectively. The Company acquired the membership interests of NASCO on August 29, 2014. NASCO is a
federally licensed tobacco products manufacturer, a participating member of the tobacco Master Settlement Agreement (“MSA”) between
the tobacco industry and the Settling States under the MSA, and operates the Company’s cigarette manufacturing business in North
Carolina. Botanical Genetics is a wholly-owned subsidiary of 22nd Century Group, and was incorporated to facilitate an equity
investment more fully described in Note 10. 22nd Century Asia was newly-formed during the third quarter of 2014 in connection with the
Company’s efforts to sell its proprietary tobacco products in Asia, more fully described in Note 6.
Preferred Stock Authorized - The Company is authorized to issue “blank check” preferred stock, which could be issued with
voting, liquidation, dividend and other rights superior to our common stock. On January 11, 2013, the Company designated the rights of
and issued 2,500 shares of Series A-1 Preferred Stock. As of June 7, 2013, all 2,500 outstanding shares of Series A-1 Preferred Stock
were converted into an aggregate of 4,166,666 shares of common stock of the Company and no shares of preferred stock remain
outstanding.
Concentration of Credit Risk - Financial instruments that potentially subject the Company to concentration of credit risk consist
of cash accounts in financial institutions. Although the cash accounts exceed the federally insured deposit amount, management does not
anticipate nonperformance by the financial institutions. Management reviews the financial viability of these institutions on a periodic
basis.
Inventory - Inventories are valued at the lower of cost or market. Cost is determined using an average cost method for tobacco
leaf inventory and the first-in, first-out (FIFO) method on all other inventories. Inventories are evaluated to determine whether any
amounts are not recoverable based on slow moving or obsolete condition and are written off or reserved as appropriate. Inventories at
December 31, 2014 and 2013 consist of the following:
Inventory - tobacco leaf
Less: inventory reserve
Inventory - tobacco leaf, net
Inventory - finished goods
Cigarettes and filtered cigars
Inventory - raw materials
Cigarette and filtered cigar components
December 31, 2014 December 31, 2013
$
1,537,521 $
50,623
1,486,898
1,398,747
50,623
1,348,124
154,568
13,206
423,330
44,950
$
2,064,796 $
1,406,280
Fixed assets – Fixed assets are recorded at their acquisition cost and depreciated on a straight line basis over their estimated
useful lives ranging from 3 to 10 years. Depreciation commences when the asset is placed in service.
F-8
Intangible Assets - Intangible assets are recorded at cost and consist primarily of (1) expenditures incurred with third parties
related to the processing of patent claims and trademarks with government authorities, as well as costs to acquire patent rights from third
parties, (2) license fees paid for third-party intellectual property, (3) costs to become a signatory under the tobacco Master Settlement
Agreement (“MSA”), and (4) license fees paid to acquire a predicate cigarette brand. The amounts capitalized relate to intellectual
property that the Company owns or to which it has exclusive rights. The Company’s intellectual property capitalized costs are amortized
using the straight-line method over the remaining statutory life of the primary patent in each of the Company’s two primary patent
families, which expire in 2019 and 2028 (the assets’ estimated lives, respectively). Periodic maintenance or renewal fees are expensed as
incurred. Annual minimum license fees are charged to expense. License fees paid for third-party intellectual property are amortized on a
straight-line basis over the last to expire patents, which patent expiration dates range from 2028 through 2035. The Company believes
costs associated with becoming a signatory to the MSA and acquiring the predicate cigarette brand have an indefinite life and as such, no
amortization is taken. Total intangible assets at December 31, 2014 and December 31, 2013 consist of the following:
Intangible assets, net
Patent and trademark costs
Less: accumulated amortization
Patent and trademark costs, net
License fees, net (see Note 17)
Less: accumulated amortization
License fees, net
MSA signatory costs (see Note 7)
License fee for predicate cigarette brand
December 31,
2014
December 31,
2013
$
4,405,586 $
1,247,303
3,158,283
2,559,412
1,014,543
1,544,869
1,450,000
32,524
1,417,476
2,202,000
300,000
-
-
-
-
-
$
7,077,759 $
1,544,869
Amortization expense relating to the above intangible assets for the years ended December 31, 2014 and 2013 amounted to
$265,284 and $141,261, respectively.
During the year ended December 31, 2013, the Company changed the estimated useful life of one of the patent families. The
change did not have a material impact on the financial statements.
The estimated annual average amortization expense for the next five years is approximately $310,000 for patent costs and
$98,000 for license fees.
Impairment of Long-Lived Assets - The Company reviews the carrying value of its amortizing long-lived assets whenever
events or changes in circumstances indicate that the historical cost-carrying value of an asset may no longer be recoverable. The Company
assesses recoverability of the asset by estimating the future undiscounted net cash flows expected to result from the asset, including
eventual disposition. If the estimated future undiscounted net cash flows are less than the carrying value of the asset, an impairment loss is
recorded equal to the difference between the asset’s carrying value and its fair value. There was no impairment loss recorded during the
years ended December 31, 2014 or 2013.
Income Taxes - The Company recognizes deferred tax assets and liabilities for any basis differences in its assets and liabilities
between tax and GAAP reporting, and for operating loss and credit carry-forwards.
In light of the Company’s history of cumulative net operating losses and the uncertainty of their future utilization, the Company
has established a valuation allowance to fully offset its net deferred tax assets as of December 31, 2014 and 2013.
F-9
The Company’s federal and state tax returns for the years ended September 30, 2011 to December 31, 2013 are currently open to
audit under the statutes of limitations. There are no pending audits as of December 31, 2014.
Refundable taxes and tax credits – The Company accounts for income tax refunds or tax refundable tax credits as discrete items
and recognized the amount in the period in which the funds are received. During the year ended December 31, 2013, the Company
received notice from the New York State Department of Taxation and Finance of a no change audit with respect to its income tax return
filed for the period ending September 30, 2011. The subject return contained a refundable credit in the amount of $122,024. The refund
was recorded as Other income in the Company’s Consolidated Statement of Operations for the year ended December 31, 2013. There
were no such transactions during the year ended December 31, 2014.
Stock Based Compensation - The Company uses a fair-value based method to determine compensation for all arrangements
under which Company employees and others receive shares, options or warrants to purchase common shares of 22nd Century Group.
Stock based compensation expense is recorded over the requisite service period based on estimates of probability and time of achieving
milestones and vesting. For accounting purposes, the shares will be considered issued and outstanding upon vesting.
Revenue Recognition – The Company recognizes revenue from product sales at the point the product is shipped to a customer
and title has transferred. Revenue from the sale of the Company’s products is recognized net of cash discounts, sales returns and
allowances. Cigarette federal excise taxes are included in net sales and accounts receivable billed to customers, except on sales of
SPECTRUM research cigarettes and exported cigarettes, to which such taxes do not apply.
The Company was chosen to be a subcontractor for a 5-year government contract between RTI International (“RTI”) and the
National Institute on Drug Abuse (“NIDA”) to supply NIDA with research cigarettes. These government research cigarettes are
distributed under the Company’s mark, SPECTRUM. In September 2013, the Company received a purchase order for 5.5 million
SPECTRUM research cigarettes that were shipped in January 2014. Total revenue from this order was approximately $448,000 for the
year ended December 31, 2014. A down payment of $179,014 was received in the fourth quarter of 2013 and was recorded as deferred
revenue on the Company’s balance sheet at December 31, 2013. There were no SPECTRUM cigarettes delivered during the year ended
December 31, 2013.
The Company licenses its patented technology to third parties. Revenue is recognized from licensing arrangements as
contractually defined in licensing agreements. The Company accounts for milestones elements contained in licensing agreements in
accordance with ASC 605. On October 1, 2013, 22nd Century Ltd entered into a worldwide Research License and Commercial Option
Agreement (the “Agreement”) with British American Tobacco (Investments) Limited (“BAT”), a subsidiary of British American
Tobacco plc, that grants BAT access to 22nd Century Ltd’s patented technology which alters levels of nicotinic alkaloids in tobacco
plants. Simultaneous with the signing of the Agreement, BAT paid the Company a non-refundable $7,000,000. The Company will be
entitled to receive additional payments from BAT of up to an additional $7,000,000 during the term of the Research License in the event
certain milestones are met with respect to the ongoing research and development of the Company’s licensed technology to BAT. No
amount related to the additional research milestones was recognized during the year ended December 31, 2014. During the term of the
Research License, BAT will have the option to enter into a Commercial License agreement which will provide for future annual
payments, royalty payments and minimum annual royalties. A portion of the patented technology sublicensed to BAT was exclusively
licensed to 22nd Century Ltd by a third party licensor proir to the acquisition by 22nd Century Ltd of such patented technology from such
licensor on December 23, 2014 (see Note 12 for the more detailed discussion). Pursuant to the terms of the license agreement with such
licensor, 22nd Century Ltd was obligated to make a royalty payment to the licensor with respect to a portion of the non-refundable
$7,000,000 paid by BAT to the Company on October 1, 2013. From October 2013 to September 2014, 22nd Century Ltd and the third
party licensor were in discussions as to the amount of royalty due to the licensor from 22nd Century Ltd. During the quarter ended
September 30, 2014, 22nd Century Ltd and the third party licensor mutually agreed on a payment of $660,000 that was paid in December
2014. 22nd Century Ltd had previously estimated the payment to be $413,566. The difference in the amount of $246,434 has been
recorded as Royalty for licensing in the Cost of goods sold section of the Company’s Consolidated Statements of Operations for the year
ended December 31, 2014.
F-10
Derivatives – The Company does use derivative instruments to hedge exposures to cash flow, market or foreign currency risks.
The Company evaluates all of its financial instruments to determine if such instruments are derivatives or contain features that qualify as
embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially
recorded at its fair market value and then is revalued at each reporting date, with changes in fair value reported in the consolidated
statement of operations. The methodology for valuing outstanding warrants classified as derivative instruments utilizes a lattice model
approach which includes probability weighted estimates of future events including volatility of our common stock. The classification of
derivative instruments, including whether such instruments should be recorded as liabilities or equity, is evaluated at the end of each
reporting period. Derivative instrument liabilities are classified on the balance sheet as current or non-current based on whether or not net-
cash settlement of the derivative instrument could be required within twelve months of the balance sheet date.
Research and Development - Research and development costs are expensed as incurred.
Loss Per Common Share - Basic loss per common share is computed using the weighted-average number of common shares
outstanding. Diluted loss per share is computed assuming conversion of all potentially dilutive securities. Potential common shares
outstanding are excluded from the computation if their effect is anti-dilutive.
Commitment and Contingency Accounting - The Company evaluates each commitment and/or contingency in accordance with
the accounting standards, which state that if the item is more likely than not to become a direct liability, then the Company will record the
liability in the financial statements. If not, the Company will disclose any material commitments or contingencies that may arise.
Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the
United States (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and
expenses during the reporting period. Actual results could differ from those estimates.
Fair Value of Financial Instruments - Financial instruments include cash, receivables, accounts payable, accrued expenses,
demand bank loan, and warrant liability. Other than warrant liability, fair value is assumed to approximate carrying values for these
financial instruments, since they are short term in nature, they are receivable or payable on demand, or had stated interest rates that
approximate the interest rates available to the Company as of the reporting date. The determination of the fair value of the warrant
liability includes unobservable inputs and is therefore categorized as a Level 3 measurement, as further discussed in Note 15.
Equity Investments – The Company accounts for investments in equity securities of other entities under the equity method of
accounting if the Company’s investment in the voting stock is greater than or equal to 20% and less than a majority, and the Company has
the ability to have significant influence over the operating and financial policies of the investee.
Accounting Pronouncements - In May 2014, the FASB issued ASU 2014-09, ”Revenue from Contracts with Customers”, which
supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize
revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity
expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so,
more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP. The
standard is effective for annual periods beginning after December 15, 2016, and interim periods therein, using either of the following
transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option
to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09
recognized at the date of adoption (which includes additional footnote disclosures). The Company is currently evaluating the impact of the
pending adoption of ASU 2014-09 on its consolidated financial statements and have not yet determined the method by which it will adopt
the standard in 2017.
F-11
NOTE 2. – NYSE MKT EXCHANGE
On March 11, 2014, the Company’s common stock began trading on the NYSE MKT exchange under the ticker symbol XXII.
The Company’s common stock had been previously quoted on the OTC Bulletin Board under the ticker symbol of XXII.OB.
NOTE 3. – FINANCIAL CONDITION
At December 31, 2014, the Company had current assets of $10,706,806 and current liabilities of $2,673,407 resulting in positive
working capital of $8,033,399. Cash on hand at December 31, 2014 was $6,402,687. The Company believes it will have adequate cash
reserves to sustain operations and meet all current obligations as they come due for a period of approximately 12 months.
The Company’s Form S-3 universal shelf registration statement was filed with the U.S. Securities and Exchange Commission
(“SEC”) on April 18, 2014, and became effective on June 5, 2014. The universal shelf registration statement will allow, but not compel,
the Company to raise up to $45 million of capital over a three-year period through a wide array of securities at times and in amounts to be
determined by the Company.
NOTE 4. – SEPTEMBER 2014 COMMON STOCK PRIVATE PLACEMENT
On September 17, 2014, the Company issued 3,871,767 shares of its common stock for $10,000,000. Net cash proceeds from the
issuance were $9,324,088 after deducting expenses associated with the common stock issuance.
As a condition of the private placement, the parties executed a Registration of Rights Agreement pursuant to which the Company
agreed to provide certain registration rights with respect to certain of the issued securities under the Securities Act of 1933. Accordingly,
on October 10, 2014, the Company filed a Form S-3 Registration Statement with the SEC. On October 23, 2014, the SEC declared the
Registration Statement effective.
NOTE 5. - JANUARY 2013 PREFERRED STOCK PRIVATE PLACEMENT
On January 11, 2013, the Company sold 2,500 shares of newly created Series A-1 10 % Convertible Preferred Stock (the “Series
A-1 Preferred Stock”) and warrants for $2.5 million. Net proceeds from this issuance were $2.035 million. During 2013, all Series A-1
Preferred Stock was converted into shares of the Company’s common stock and all related warrants to purchase shares of the Company’s
common stock were exercised. Net proceeds from the exercise of warrants to purchase shares of the Company’s common stock were
$2.090 million.
NOTE 6. – CONSULTING AGREEMENT AND JOINT VENTURE
In connection with a joint venture arrangement entered into on September 29, 2014 by the Company’s newly-formed and 51%
owned subsidiary, 22nd Century Asia, the Company entered into a six-month Consulting Agreement (the “Consulting Agreement”) with
Crede CG III, Ltd. (“Crede”). Crede will provide consulting services to 22nd Century Asia with respect to the Company’s efforts to sell
its proprietary tobacco products into the Asian market. In connection with the Company’s entry into such a joint venture and the
Consulting Agreement, the Company issued Crede 1,250,000 Tranche 1A Warrants (the “Tranche 1A Warrants”) and 1,000,000 Tranche
1B Warrants (the “Tranche 1B Warrants”). The Tranche 1A Warrants have an exercise price of $3.36 per share and the Tranche 1B
Warrants have an exercise price of $2.5951 per share. The Tranche 1A Warrants and the Tranche 1B Warrants each have a term of two
years and are exercisable at any time. In addition, the Company issued 1,000,000 Tranche 2 Warrants (the “Tranche 2 Warrants”) and
1,000,000 Tranche 3 Warrants (the “Tranche 3 Warrants”). The Tranche 2 Warrants and the Tranche 3 Warrants each have a term of 5
years and an exercise price of $3.3736 per share. The Tranche 2 Warrants and Tranche 3 Warrants only become exercisable if certain
revenue milestones are met by 22nd Century Asia subsequent to a certain commencement date, such commencement date likely to occur
between January 1, 2016 and January 1, 2017, and the Company is cash flow positive from its investment in 22nd Century Asia. The
Tranche 1A Warrants, the Tranche 1B Warrants, the Tranche 2 Warrants and the Tranche 3 Warrants all contain a traditional cashless
exercise provision.
F-12
In addition to the traditional cashless exercise provision, the Tranche 1A Warrants contain an Exchange Rights clause (the
“Exchange Rights”) that provides that the Tranche 1A Warrants may be exercised on cashless basis by exchanging such warrants for
shares of the Company’s common stock using a negotiated Black-Scholes pricing formula beginning on the day that is sixty one days
after September 17, 2014, subject to certain conditions in the Exchange Rights. The number of shares issuable pursuant to the Exchange
Rights is determined by dividing (a) the product of the number of Tranche 1A Warrants to be exchanged and the per share price resulting
from the negotiated Black-Scholes pricing formula, by (b) the Exchange Price, defined as the closing bid price of the Company’s
common stock two days prior to the date of the exchange. The maximum number shares issuable under the Exchange Rights is limited to
5,000,000 shares.
The Company valued the Tranche 1A Warrants and Tranche 1B Warrants using the Black-Scholes pricing model as of the date of
issuance. The resulting fair value of the Tranche 1A Warrants and Tranche 1B Warrants amounted to $2,810,000 and $1,260,000,
respectively, and have been recorded as Prepaid consulting fees on the Company’s Consolidated Balance Sheets and are being amortized
over the six month term of the Consulting Agreement. During the year ended December 31, 2014, $2,091,215 of the Prepaid consulting
fees were amortized and are included in General and administrative costs on the Company’s Consolidated Statements of Operations. The
Exchange Rights contained in the Tranche 1A Warrants cause the financial instrument to be considered a liability in accordance with
FASB Accounting Standards Codification Topic 480 – “Distinguishing Liabilities from Equity” (“ASC 480”). More specifically, ASC
480 requires a financial instrument to be classified as a liability if such financial instrument contains a conditional obligation that the
issuer must or may settle by issuing a variable number of its equity securities if, at inception, the monetary value of the obligation is
based on a known fixed monetary amount. As such, the fair value of the Tranche 1A Warrants are included in the Warrant liability on the
Company’s Consolidated Balance Sheets at December 31, 2014. The Tranche 1B Warrants do not contain such Exchange Rights and
accordingly the fair value has been recorded as an increase in capital. No value has been assigned to the Tranche 2 Warrants and the
Tranche 3 Warrants as they are not exercisable until certain revenue milestones are attained, as described above.
NOTE 7. – BUSINESS COMBINATION
On September 17, 2013, the Company entered into a Membership Interest Purchase Agreement, which was subsequently
amended on May 13, 2014, to purchase all of the issued and outstanding membership interests of NASCO Products, LLC (“NASCO”), a
North Carolina limited liability company (the “Transaction”). NASCO is a federally licensed tobacco product manufacturer and a
participating member of the tobacco Master Settlement Agreement known as the MSA, an agreement among 46 U.S. states and the
tobacco industry administered by the National Association of Attorneys General (“NAAG”). The Transaction was subject to various
conditions, including the required consents of the Settling States of the MSA to an amendment of NASCO’s existing adherence agreement
to the MSA, with the Company becoming a signatory to such amended adherence agreement as part of the Company’s acquisition of
NASCO. On August 29, 2014, the Company became a signatory to the amended adherence agreement under the MSA, and accordingly,
the Transaction closed on August 29, 2014.
The purchase price for the Transaction (the “Purchase Price”) consisted of (i) a cash payment of $250,000 and (ii) the issuance of
640,000 unregistered shares of the Company’s common stock. The common stock issued on August 29, 2014 had a market value of
$1,952,000, resulting in a total Purchase Price of $2,202,000. The Purchase Price has been recorded as an Intangible asset in the Other
assets section of the Company’s Consolidated Balance Sheets. The Company believes the intangible asset has an indefinite life and as
such, no amortization is recorded. The Company also acquired cash of approximately $105,000 and a like amount of accrued expenses.
In connection with the initial recording of the acquisition the Company recorded a deferred tax liability associated with the excess
of the book value over the tax basis of assets acquired during the third quarter of 2014. During the final accounting for the acquisition it
was determined that the book and tax basis were equal and the need for the deferred tax liability was no longer necessary. As a result, the
initial recording of the deferred tax liability and associated goodwill from August 2014 was reversed.
F-13
NOTE 8. – MANUFACTURING FACILITY
On December 11, 2013, the Company closed on a $3,220,000 purchase of certain cigarette manufacturing equipment from the
bankruptcy estate of a company located in North Carolina that was liquidating under Chapter 7 of the U.S. Bankruptcy Code.
Additionally, on January 13, 2014, the Company closed on a $210,000 purchase of various cigarette manufacturing equipment parts,
office furniture and fixtures, vehicles and computer software and equipment from a second bankruptcy estate of a company located in
North Carolina that was liquidating under Chapter 7 of the U.S. Bankruptcy Code. A portion of the equipment from these two transactions
was not required for the Company’s manufacturing operations and was subsequently sold at auction during the first quarter of 2014.
The Company’s warehouse and cigarette manufacturing facility was primarily in a pre-manufacturing stage during the year ended
December 31, 2014. During this time period, the Company incurred various expenses to prepare the facility for production. Expenses
incurred during the year ended December 31, 2014 amounted to $1,176,676 and consisted primarily of expenses for salaries and benefits
for employees, sub-contract labor, rent, utilities and other miscellaneous costs and are reported as Pre-manufacturing facility costs on the
Company’s Consolidated Statements of Operations. During the second quarter of 2014, the Company placed $2,997,140 of cigarette
manufacturing equipment in service. Depreciation taken on the equipment during the year ended December 31, 2014 amounted to
$224,519 and is included in Amortization and depreciation on the Company’s Consolidated Statements of Operations. The Company did
manufacture a quantity of filtered cigars during the year ended December 31, 2014 resulting in revenue of $81,456. As discussed in Note
7, on August 29, 2014, the Company closed on the acquisition of NASCO. Accordingly, the Company and NASCO are now signatories
under the MSA. NASCO commenced manufacturing the Company’s proprietary cigarette brands and an MSA brand for an independent
chain of retail smoke shops during the fourth quarter of 2014 at its manufacturing facility. Sales of these MSA brands commenced during
the first quarter of 2015. NASCO will also continue to manufacture non-MSA filtered cigars.
NOTE 9. – MACHINERY AND EQUIPMENT
Machinery and equipment at December 31, 2014 and 2013 consists of the following:
Cigarette manufacturing equipment
Office furniture, fixtures and equipment
Leasehold improvements
Deposit for purchase of machine parts and other assets
Less: cigarette manufacturing equipment held for resale
Less: accumulated depreciation
Machinery and equipment, net
$
December 31,
2014
3,031,375 $
55,355
-
-
3,086,730
-
3,086,730
236,115
2,850,615 $
$
December 31,
2013
3,220,000
17,059
14,500
210,000
3,461,559
457,696
3,003,863
6,103
2,997,760
On December 11, 2013 and January 13, 2014, the Company acquired machinery and equipment in the amount of $3,220,000 and
$210,000, respectively, as described in Note 8. A portion of the equipment from these two transactions was not required for the
Company’s manufacturing operations and was subsequently sold at auction during the first quarter of 2014. The Company allocated
$457,696 and $88,167 of the purchase price of these sold assets from the two transactions, respectively. The Company realized net
proceeds from the auction sale of $631,484, resulting in a gain on the sale of assets of $85,621. The remaining cigarette manufacturing
equipment was placed in service during the second quarter of 2014. Depreciation expense was $230,012 and $3,027 for the years ended
December 31, 2014 and 2013, respectively.
F-14
NOTE 10. – EQUITY INVESTMENT AND ADVANCE
On April 11, 2014, the Company, through a newly formed wholly-owned subsidiary, Botanical Genetics, LLC, entered into an
investment agreement (the “Agreement”) with Anandia Laboratories, Inc., a Canadian plant biotechnology company (“Anandia”). The
Agreement provided for the Company to make an initial investment of $250,000 in Anandia in return for (i) a ten percent (10%) equity
interest in Anandia, and (ii) certain rights granted to the Company for four patent families (the “Intellectual Property”). The $250,000
investment was made on April 14, 2014. On September 15, 2014, certain milestones were achieved triggering an additional cash
investment in Anandia in the amount of $450,000 in return for (i) an additional fifteen percent (15%) equity interest in Anandia, and (ii) a
worldwide sublicense agreement to the Intellectual Property, including an exclusive sublicense agreement within the U.S. In addition, the
Company issued 150,000 unregistered shares of the Company’s common stock to Anandia with a value on the day of issuance in the
amount of $394,500, and on March 31, 2015, the Company will issue to Anandia unregistered shares of the Company’s common stock
with an aggregate market value of $325,000 at the time of the issuance. The additional $325,000 payable in shares of common stock is
included in the Equity investment and in Accrued expenses on the Company’s Consolidated Balance Sheets at December 31, 2014.
In January 2014, the Company made a non-interest bearing advance to Anandia in the amount of $92,894. $50,000 of this amount
was applied to a sublicense fee paid to Anandia, under a certain sublicense more fully described in Note 17. The balance of $42,894 has
been written off and is included in General and administrative expense on the Company’s Consolidated Statements of Operations.
The Company uses the equity method of accounting to record its 25% ownership interest in Anandia. As of December 31, 2014,
the Company’s equity investment balance in Anandia was $1,318,335 and is classified within Other assets on the accompanying
Consolidated Balance Sheets. As of December 31, 2014, the carrying value of our investment in Anandia was approximately $1,199,000
in excess of our share of the book value of the net assets of Anandia, with such difference attributable to intangible assets. This intangible
asset is being amortized over the expected benefit period and this amortization expense of $16,815 has been included in the Loss on
equity investment in the accompanying Consolidated Statements of Operations. In addition, the Company has recorded an equity loss of
$84,350, representing 25% of Anandia’s net loss covering the period beginning with the Company’s initial investment through December
31, 2014, resulting in a total loss on equity investment of $101,165.
NOTE 11. - DEMAND BANK LOAN
The demand loan is among the Company’s short term liabilities and is payable to a commercial bank under a revolving credit
agreement and is guaranteed by a former officer and current director of the Company. This loan had a balance of $174,925 at December
31, 2014 and 2013. The Company is required to pay interest monthly at an annual rate of 0.75% above the prime rate, or 4.00% at
December 31, 2014 and 2013. The Company is current in meeting this interest payment obligation. The terms of the demand loan include
an annual “clean-up” provision, which requires the Company to repay all principal amounts outstanding for a period of 30 consecutive
days every year. The Company has not complied with this requirement; however, the bank has not demanded payment. The bank has a
lien on all of the Company’s assets.
NOTE 12. - NOTES PAYABLE AND PATENT ACQUISITION
On December 22, 2014, the Company entered into a Purchase Agreement (the “Agreement”) with the National Research Council
of Canada (“NRC”) to acquire certain patent rights that the Company had previously licensed from NRC under a license agreement
between the parties. The Purchase Agreement provided for the payment by the Company to NRC of the total amount of $1,873,000, of
which (i) $660,000 was required to be paid at the closing under the Purchase Agreement for the payment due in 2013 from the Company
to NRC as a result of the monies received by the Company from BAT in October 2013, and (ii) the remaining balance of $1,213,000
being for the purchase of the NRC patent rights, of which $213,000 was paid in cash at the closing on December 23, 2014, and with the
remaining $1,000,000 balance to be paid in three equal installments of approximately $333,333 in December of 2015, 2016 and 2017,
respectively, with no interest on the installment payments unless the Company defaults in any such installment payment. As such, the
Company computed the present value of the note payable using the Company’s incremental borrowing rate. The resulting present value of
the note payable amounted to $925,730; with $320,513 and $605,217 recorded as the current and long-term portion of the note payable,
respectively. The cost of the acquired patents in the amount of $1,138,730 (cash of $213,000 plus the discounted notes payable in the
amount of $925,730) are included in Intangible assets, net on the Company’s Consolidated Balance Sheets. All previous license
agreements between NRC and the Company were terminated as a condition of the Purchase Agreement. NRC has a security interest in
these patent rights acquired by the Company from NRC until the note payable has been satisfied.
F-15
NOTE 13. – SEVERANCE LIABILITY
As of December 31, 2014, the Company has recorded an accrual for service in the amount of $624,320 in accordance with FASB
ASC 712. The severance accrual relates to the October 25, 2014 termination of Joseph Pandolfino, the Company’s former Chairman of
the Board and Chief Executive Officer, pursuant to Section 4.2 (Termination by the Company Without Cause) of Mr. Pandolfino’s
Employment Agreement, dated as of January 25, 2011. The Employment Agreement stipulates that Mr. Pandolfino shall receive
severance payments in the gross amount of $18,750 per month, subject to customary withholdings, over a term of 36 months. Amounts
owed Mr. Pandolfino have been discounted using the Company’s incremental borrowing rate, resulting in current and long-term liabilities
of $212,012 and $412,308, respectively. In addition, 320,000 unvested equity awards vested upon termination. The additional equity
based compensation of approximately $60,000 associated with the vesting of these equity awards was recorded as expense during the
fourth quarter of 2014.
NOTE 14. - DUE FROM RELATED PARTY
The Company has conducted transactions with a related party, Alternative Cigarettes, Inc. (“AC”). AC is entirely owned by
certain shareholders of the Company, including the Company’s former CEO and current director. During the years ended December 31,
2014 and 2013, transactions with AC consisted mainly of advances and repayments. The net amount due from AC amounted to $46,069
and $42,069 as of December 31, 2014 and 2013, respectively. No interest has been accrued or paid on amount due from or to AC and
there are no repayment terms.
NOTE 15. - WARRANT EXCHANGE PROGRAM AND WARRANTS FOR COMMON STOCK
During the fourth quarter of 2013, the Company initiated a warrant exchange program (the “Warrant Exchange Program”) with
existing warrant holders. As a result of the Warrant Exchange Program, the Company had 10,653,469 outstanding warrants remaining at
December 31, 2013, a reduction from 19,616,308, as of September 30, 2013. Of the remaining outstanding warrants at December 31,
2013, 3,921,381 warrants contained anti-dilution features that provide for adjustments to the exercise price and number of warrants
outstanding if the Company issues shares of common stock of 22nd Century Group at a price that is less than the respective warrant
exercise prices. These provisions require that such warrants be classified as derivatives for accounting purposes, which means they are
reported as a liability and adjusted to fair value at each balance sheet date.
In March 2014, the Company entered into warrant amendments with existing warrant holders (the “Warrant Amendments”) with
the goal of further reducing the Company’s warrant liability. To that end, the Company offered financial inducements to certain non-
management warrant holders to (i) exercise their warrants on a cash basis, (ii) exercise their warrants on a cashless basis, or (iii) agree to
have the anti-dilution feature removed from their warrants in exchange for a reduction in the exercise price contained in their respective
warrants. The warrant holders also had the option to maintain the terms and conditions of their original warrant. Management elected to
have the anti-dilution feature removed from their warrants without inducement. As a result of the Warrant Amendments, subsequent
warrant exercises during the year ended December 31, 2014, and additional warrants issued during the third quarter of 2014, there are
13,544,600 warrants outstanding at December 31, 2014 that do not contain the anti-dilution features. A total of 129,809 warrants
containing anti-dilution features remain outstanding at December 31, 2014. The Company calculated the cost of inducement as the
difference between the fair value of the warrants immediately after the Warrant Amendments closed, less the fair value of the warrants
immediately prior to the completion of the Warrant Amendments. The Company estimated the total cost of inducement to be $144,548.
This expense has been recorded as an Other expense on the Company’s Consolidated Statements of Operations, and as an increase to the
derivative warrant liability that was subsequently reversed into capital.
F-16
As discussed in Note 6, the Company issued warrants to Crede on September 29, 2014, in connection with a joint venture and
Consulting Agreement, whereby Crede will provide consulting services to 22nd Century Asia with respect to the Company’s efforts to
sell its proprietary tobacco products into the Asian market. The terms and conditions relating to the issued warrants are discussed in
detail in Note 6.
Outstanding warrants at December 31, 2014 consist of the following:
Warrant Description
January 2011 PPO $3.00 warrants
January 2011 PPO $3.00 warrants
January 2011 PPO $3.00 warrants
January 2011 PPO $1.50 warrants
January 2011 PPO $1.50 warrants (1)
January 2011 PPO $1.50 warrants
January 2011 PPO $1.50 warrants
December 2011 convertible NP warrants
December 2011 convertible NP warrants
May 2012 PPO warrants
November 2012 PPO warrants
August 2012 convertible NP warrants(1)
August 2012 convertible NP warrants
Crede Tranche 1A Warrants (2)
Crede Tranche 1B Warrants
Crede Tranche 2 Warrants (3)
Crede Tranche 3 Warrants (3)
Total warrants outstanding (4)
Number of
Warrants
Exercise
Price
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
2,817,952
653,869
3,062,665
292,965
37,177
62,329
10,831
172,730
802,215
401,700
925,100
92,632
92,244
1,250,000
1,000,000
1,000,000
1,000,000
13,674,409
2.2029
2.0000
1.9600
1.2672
1.2018
1.2018
1.1718
1.1984
1.3816
0.6000
0.6000
0.9520
0.9060
3.3600
2.5951
3.3736
3.3736
Expiration
January 25, 2016
January 25, 2016
January 25, 2016
January 25, 2016
January 25, 2016
January 25, 2016
January 25, 2016
February 8, 2017
February 6, 2018
May 15, 2017
November 9, 2017
August 8, 2018
August 8, 2018
September 29, 2016
September 29, 2016
September 29, 2019
September 29, 2019
(1) Includes anti-dilution features.
(2) Include Exchange Rights (see Note 6 for detailed discussion).
(3) Exercisable upon attainment of certain revenue milestones (see Note 6 for detailed discussion).
(4) Includes 3,725,962 warrants (27.3%) held by officers and directors that have had the anti-dilution feature removed.
The Company estimates the value of warrant liability upon issuance of the warrants and at each balance sheet date using the
binomial lattice model to allocate total enterprise value to the warrants and other securities in the Company’s capital structure. Volatility
was estimated based on historical observed equity volatilities and implied (forward) or expected volatilities for a sample group of
guideline companies and consideration of recent market trends.
As a result of the Exchange Rights contained in the Tranche 1A Warrants, the financial instrument is considered a liability in
accordance with FASB Accounting Standards Codification Topic 480 – “Distinguishing Liabilities from Equity” (“ASC 480”). More
specifically, ASC 480 requires a financial instrument to be classified as a liability if such financial instrument contains a conditional
obligation that the issuer must or may settle by issuing a variable number of its equity securities if, at inception, the monetary value of
the obligation is based on a known fixed monetary amount.
F-17
The following table is a roll-forward summary of the warrant liability:
Fair value at December 31, 2012
Fair value of warrant liability upon conversion of remaining December 14, 2011 Notes – Q1 2013
Fair value of warrant liability upon issuance - Q1 2013
Fair value of warrant liability upon issuance - Q2 2013
Fair value of warrant liability upon issuance - Q3 2013
Fair value of warrant liability upon conversion of August 9, 2012 Notes - Q3 2013
Fair value of warrant liability upon reduction of exercise price of Series A and Series C warrants – Q3 2013
Reclassification of warrant liability to equity upon exercise of warrants - Q2 2013
Reclassification of warrant liability to equity upon exercise of warrants - Q3 2013
Reclassification of warrant liability to equity upon exercise of warrants - Q4 2013
Cost of inducement from Warrant Exchange Program - Q4 2013
Reclassification of warrant liability to equity resulting from Warrant Exchange Program - Q4 2013
Loss as a result of change in fair value
Fair value at December 31, 2013
Reclassification of warrant liability to equity resulting from Warrant Amendments - Q1 2014
Cost of inducement from Warrant Amendments - Q1 2014
Fair value of warrant liability resulting from issuance of Crede Tranche 1A Warrants – Q3 2014
Loss as a result of change in fair value
Fair value at December 31, 2014
$
$
$
4,173,140
1,445,091
6,022,319
711,675
1,622,069
731,662
626,328
(204,513)
(6,542,904)
(7,712,170)
3,274,313
(19,639,465)
19,271,977
3,779,522
(7,367,915)
144,548
2,810,000
3,676,691
3,042,846
The aggregate net loss as a result of the Company’s warrant liability for the years ended December 31, 2014 and 2013 amounted
to $3,676,691 and $19,271,977, respectively, which is included in Other income (expense) as part of Warrant liability loss – net in the
accompanying Consolidated Statements of Operations. The loss for the year ended December 31, 2013, also includes a charge to Other
income (expense) in the amount of $4,330,734 as a result of (i) warrant liabilities issued in connection with the Series A-1 Preferred Stock
in excess of net proceeds raised in the amount of $3,987,655 in January 2013, and (ii) warrant liabilities issued in connection with the July
2013 issuance of 1,101,034 Series C Warrants in excess of the sum of the net process received upon exercise and the reclassification of
the warrant liability to capital, in the amount of $343,079. Warrant liabilities issued during the year ended December 31, 2013, in
connection with the December 14, 2011 convertible notes and the August 9, 2012 convertible notes converted to common stock in excess
of the conversion amount by $17,386 and $509,062, respectively, were recorded as additional interest expense.
FASB ASC 820 - “Fair Value Measurements and Disclosures” establishes a valuation hierarchy for disclosure of the inputs to
valuation used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows:
•
•
•
Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities;
Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or
liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument; and
Level 3 inputs are unobservable inputs based on the Company’s own assumptions used to measure assets and liabilities at fair
value.
A financial asset’s or a financial liability’s classification within the hierarchy is determined based on the lowest level input that is
significant to the fair value measurement. The warrant liability is measured at fair value using certain estimated factors such as volatility
and probability which are classified within Level 3 of the valuation hierarchy. Significant unobservable inputs that are used in the fair
value measurement of the Company’s derivative warrant liabilities include volatility. Significant increases (decreases) in the volatility
input would result in a significantly higher (lower) fair value measurement.
F-18
The following table summarizes the Company’s warrant activity since December 31, 2012:
Number of Warrants
Warrants outstanding at December 31, 2012
Warrants issued
Warrants issued as part of Warrant Exchange Program
Additional warrants due to anti-dilution provisions
Warrants exercised during 2013
Warrants exercised as part of Warrant Exchange Program
Warrants outstanding at December 31, 2013
Warrants issued in conjunction with consulting agreement (see Note 6)
Warrants exercised during 2014
Additional warrants due to anti-dilution provisions
Warrants outstanding at December 31, 2014
Composition of outstanding warrants:
Warrants containing anti-dilution feature
Warrants without anti-dilution feature
12,972,664
11,570,274
138,666
1,665,400
(9,831,414)
(5,862,121)
10,653,469
4,250,000
(1,247,443)
18,383
13,674,409
129,809
13,544,600 (1)
13,674,409
(1) Include 1,250,000 warrants containing Exchange Rights (see Note 6 for detailed discussion).
NOTE 16. - RETIREMENT PLAN
The Company sponsors a defined contribution plan under IRC Section 401(k). The plan covers all employees who meet the
minimum eligibility requirements. Under the 401(k) plan eligible employees are allowed to make voluntary deferred salary contribution
to the plan, subject to statutory limits. The Company has elected to make Safe Harbor Non-elective Contributions to the plan for eligible
employees in the amount of three percent (3%) of the employee’s compensation. Total employer contributions to the plan for the years
ended December 31, 2014 and 2013 amounted to $27,485 and $34,873, respectively. The contribution for the year ended December 31,
2013 includes a contribution made for 2012 in the first quarter of 2013.
NOTE 17. – COMMITMENTS AND CONTINGENCIES
License Agreements - Under its exclusive worldwide license agreement with North Carolina State University (“NCSU”), the
Company is required to pay minimum annual royalty payments, which are credited against running royalties on sales of licensed
products. The minimum annual royalty for each of 2014 and 2015 is $75,000, and in 2016 the minimum annual royalty increases to
$225,000. The license agreement continues through the life of the last-to-expire patent, which is expected to be 2022. The license
agreement also requires a milestone payment of $150,000 upon FDA approval or clearance of a product that uses the NCSU licensed
technology. The Company is also responsible for reimbursing NCSU for actual third-party patent costs incurred. These costs vary from
year to year and the Company has certain rights to direct the activities that result in these costs. During the years ended December 31,
2014 and 2013, the costs incurred related to capitalized patent costs and patent maintenance expense amounted to $123,968 and $101,902
respectively.
In addition, on February 10, 2014, the Company entered into a sponsored research and development agreement (the
“Agreement”) with NCSU. Under the terms of the Agreement, the Company is required to pay NCSU $162,408 over the two-year term
of the Agreement, which grants certain licensing rights to the Company. A payment of $81,204 was made in February 2014 and a final
payment of $81,204 is due and payable on February 1, 2015.
The Company has two other exclusive license agreements which require aggregate annual license fees of approximately $75,000,
which are credited against running royalties on sales of licensed products. Each license agreement continues through the life of the last-
to-expire patents. On December 22, 2014, the Company entered into a Purchase Agreement (see Note 12 for details) with one of these
licensors to acquire certain patent rights the Company had previously licensed from such licensor. The Company has no future
commitment to that licensor.
F-19
All payments made under the above referenced license agreements and the sponsored research and development agreement are
initially recorded as a Prepaid expense on the Company’s Consolidated Balance Sheets and subsequently expensed on a straight-line
basis over the applicable period and included in Research and development costs on the Company’s Consolidated Statements of
Operations.
On August 22, 2014, the Company entered into a Commercial License Agreement with Precision PlantSciences, Inc. (the
“Precision License”). The Precision License grants the Company a non-exclusive, but fully paid up right and license to use technology
and materials owned by Precision PlantSciences for a license fee of $1,250,000. An initial cash payment of $725,000 was made upon
execution of the Precision License with an unconditional obligation to pay the remaining $525,000 in $25,000 increments as materials are
provided to the Company. The remaining $525,000 was paid during December 2014. The Precision License continues through the life of
the last-to-expire patent, which is expected to be in 2028.
On August 27, 2014, the Company entered into an additional exclusive License Agreement (the “License Agreement”) with
NCSU. Under the License Agreement, the Company paid NCSU a non-refundable, non-creditable lump sum license fee of $125,000.
Additionally, the License Agreement calls for the Company to pay NCSU three non-refundable, non-creditable license maintenance fees
in the amount of $15,000 per annum in each of December 2015, 2016 and 2017. Beginning in calendar year 2018, the Company is
obligated to pay to NCSU an annual minimum royalty fee of $20,000 in 2018, $30,000 in 2019, and $50,000 per year thereafter for the
remaining term of the License Agreement. The Company is also responsible for reimbursing NCSU for actual third-party patent costs
incurred. There were no costs reimbursed under the License Agreement through December 31, 2014. The License Agreement continues
through the life of the last-to-expire patent, which is expected to be in 2034.
On September 15, 2014, the Company entered into a Sublicense Agreement with Anandia Laboratories, Inc. (the “Anandia
Sublicense”). Under the terms of the Anandia Sublicense, the Company was granted an exclusive sublicense in the United States and a
co-exclusive sublicense in the remainder of the world, excluding Canada, to the licensed Intellectual Property (more fully discussed in
Note 10). The Anandia Sublicense calls for an up-front fee of $75,000, an annual license fee of $10,000, and a running royalties on future
net sales. The Anandia Sublicense continues through the life of the last-to-expire patent, which is expected to be in 2035.
The Precision License, the License Agreement with NCSU and the Anandia Sublicense are included in Intangible assets, net in
the Company’s Consolidated Balance Sheets and the applicable license fees will be amortized over the term of the agreements based on
their last-to-expire patent date. Amortization during the year ended December 31, 2014 and 2013 amounted to $32,524 and $0,
respectively, and was included in Research and development costs on the Company’s Consolidated Statements of Operations.
Lease Agreements - On October 9, 2013, the Company executed a guaranty that guarantees performance by NASCO of its
obligations to a landlord under a certain triple net lease of the same date between NASCO and a landlord for a manufacturing facility and
warehouse located in North Carolina. Upon the NASCO transaction closing on August 29, 2014, the lease became a direct obligation of
the Company. The lease commenced on January 14, 2014, and has an initial term of twelve (12) months. The lease contains four (4)
additional extensions; one for an additional one (1) year and three for an additional two (2) years in duration, exercisable at the option of
NASCO. The lease expense for the year ended December 31, 2014 amounted to $97,593. The future minimum lease payments under the
lease are $123,000, $298,275, $338,250 and $338,250 during the one (1) year optional extension, and each of the three (3), two (2) year
optional extensions, respectively.
The Company has extended the lease for its office space in Clarence, New York for a one-year renewal option expiring August
31, 2015, with the Company having the option to extend this lease for either or both of two (2) additional renewal periods, each
consisting of one (1) year. Future minimum lease payments for the years ended December 31, 2015, 2016 and 2017 are approximately
$44,000, $45,000 and $31,000, respectively, if the Company exercises each of the optional renewal periods.
On January 25, 2013, the Company entered into a two and one-half year lease for manufacturing space in Depew, New York,
which commenced February 1, 2013. This lease was cancelled during the third quarter of 2014. There are no remaining rent commitments
under this lease.
F-20
NOTE 18. - EARNINGS PER COMMON SHARE
The following table sets forth the computation of basic and diluted earnings per common share for the year ended December 31,
2014 and 2013:
Net loss attributed to common shareholders
December 31,
2014
December 31,
2013
$
(15,595,358) $
(26,153,158)
Denominator for basic earnings per share-weighted average shares outstanding
59,993,413
43,635,182
Effect of dilutive securities:
Warrants, restricted stock and options outstanding
-
-
Denominator for diluted earnings per common share-weighted average shares adjusted for
dilutive securities
59,993,413
43,635,182
Loss per common share - basic and diluted
$
(0.26) $
(0.60)
Securities outstanding that were excluded from the computation of earnings per share for the year ended December 31, 2014 and
2013 because they would have been anti-dilutive are as follows:
Warrants
Restricted stock
Options
December 31,
2014
13,674,409
250,000
890,000
14,814,409
December 31,
2013
10,653,469
500,000
660,000
11,813,469
NOTE 19. - STOCK BASED COMPENSATION
On October 21, 2010, the Company established the 2010 Equity Incentive Plan (“EIP”) for officers, employees, directors,
consultants and advisors to the Company and its affiliates, consisting of 4,250,000 shares of common stock. The EIP had a term of ten
years and is administered by our Board of Directors (the “Board”) or a committee to be established by our Board (the “Administrator”),
to determine the various types of incentive awards that may be granted to recipients under this plan and the number of shares of common
stock to underlie each such award under the EIP. On March 30, 2011, the Company filed a Form S-8 registration statement with the SEC
to register all of the shares of common stock of 22nd Century Group that it may issue under the EIP.
During the first quarter of 2014, the Company issued restricted stock awards from the EIP for 850,000 restricted shares to
employees and directors that will vest on January 27, 2015. All awards were valued at the closing price on the measurement date of the
award. Subsequent to this issuance of restricted stock, there are no shares remaining to be issued from the EIP.
F-21
On April 12, 2014, the stockholders of the Company approved the 22nd Century Group, Inc. 2014 Omnibus Incentive Plan (the
“OIP”). The OIP allows for the granting of equity and cash incentive awards to eligible individuals over the life of the OIP, including the
issuance of up to 5,000,000 shares of the Company’s common stock pursuant to awards under the OIP. The OIP has a term of ten years
and is administered by the Compensation Committee of our Board of Directors to determine the various types of incentive awards that
may be granted to recipients under this plan and the number of shares of common stock to underlie each such award under the OIP. On
April 18, 2014, the Company filed a Form S-8 registration statement with the SEC to register the 5,000,000 shares of common stock of
22nd Century Group that may be issued under the OIP.
During the year ended December 31, 2014, the Company issued restricted stock awards from the OIP for 147,556 restricted
shares to eligible individuals having vesting periods ranging from zero to three years from the award date. All awards were valued at the
closing price on the measurement date of the award.
For the years ended December 31, 2014 and 2013, the Company recorded compensation expense related to restricted stock and
stock option awards granted under the EIP and OIP of $2,293,082 and $998,214, respectively. The Company also recorded equity based
compensation for the years ended December 31, 2014 and 2013 as payment to third parties for services rendered in the amount $140,170
and $1,363,748, respectively.
As of December 31, 2014, unrecognized compensation expense related to non-vested restricted shares and stock options
amounted to approximately $672,000, which is expected to be recognized approximately as follows: $473,000, $160,000, and $39,000
during 2015, 2016 and 2017, respectively.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The following
assumptions were used for the years ended December 31, 2014 and 2013:
Risk-free interest rate
Expected dividend yield
Expected stock price volatility
Expected life of options
2014
2013
1.80%
0%
90%
1.89%
0%
90%
10 years
10 years
The Company estimated the expected volatility based on data used by a peer group of public companies. The expected term was
estimated using the contract life of the option. The risk-free interest rate assumption was determined using yield of the equivalent U.S.
Treasury bonds over the expected term. The Company has never paid any cash dividends and does not anticipate paying any cash
dividends in the foreseeable future. Therefore, the Company assumed an expected dividend yield of zero.
A summary of all stock option activity since December 31, 2012 is as follows:
Number of
Options
Weighted
Average
Exercise Price
Weighted
Average
Remaining
Contractual
Term
Aggregate
Intrinsic Value
Outstanding at December 31, 2012
Granted in 2013
Exercised in 2013
Outstanding at December 31, 2013
Granted in 2014
Exercised in 2014
Outstanding at December 31, 2014
Exercisable at December 31, 2014
$
465,000
215,000
$
(20,000) $
$
660,000
300,000
$
(70,000) $
$
890,000
640,000
$
0.69
0.80
0.26
0.74
2.61
0.69
1.38
0.89
8.0 years
7.7 years
$
$
532,900
532,900
F-22
There were 300,000 options granted from the OIP during the year ended December 31, 2014 (215,000 options granted during the year ended December 31, 2013). The
weighted average grant date fair value of options issued during the year ended December 31, 2014 was $2.07 ($0.68 for the year ended December 31, 2013). The total fair value
of options that vested during the year ended December 31, 2014 amounted to $103,250 ($242,160 for the year ended December 31, 2013). During the year ended December 31,
2014, 70,000 options were exercised for cash proceeds of $48,300. During the year ended December 31, 2013, 20,000 options were exercised for cash proceeds of $5,200.
NOTE 20. - INCOME TAXES
The following is a summary of the components giving rise to the income tax provision (benefit) for the years ended December 31, 2014 and 2013.
The provision (benefit) for income taxes consists of the following:
2014
2013
Current:
Federal
State
Total current
Deferred:
Federal
State
Total deferred
Change in valuation allowance
$
$
- $
-
-
-
-
-
(3,494,787)
160,319
(3,334,468)
3,334,468
- $
829,306
186,414
1,015,720
(1,015,720)
-
The provision (benefit) for income tax varies from that which would be expected based on applying the statutory federal rate to pre-tax accounting loss as follows:
Statutory federal rate
Permanent items
Derivative liability
Stock based compensation
State tax provision, net of federal benefit
Valuation allowance
Effective tax rate (benefit) provision
Individual components of deferred taxes consist of the following:
Deferred tax assets:
Net operating loss carry-forward
Derivative liability
Inventory reserve
Stock-based compensation
Start-up expenditures
Loss on equity investment
Severance liability
Other
Deferred tax liabilities:
Inventory
Fixed assets
Patents and trademarks
Other intangible assets
Valuation allowance
Net deferred taxes
2014
2013
(34.0)%
0.6
8.4
2.5
1.1
21.4
0.0%
(34.0)%
1.8
35.5
-
0.5
(3.9)
0.0%
$
2014
2013
4,775,536 $
-
17,713
809,319
388,130
35,398
218,450
6,561
6,251,107
-
(80,251)
(624,010)
(21,986)
(726,247)
(5,524,860)
2,616,624
21,725
19,584
131,450
-
-
-
1,292
2,790,675
(52,445)
(2,956)
(523,157)
-
(578,558)
(2,212,117)
$
- $
-
The Company has incurred a net operating loss of approximately $13,700,000 through December 31, 2014 and this amount is being carried forward to future years and
expires in 2031 and 2032. Due to the uncertainty of the Company’s ability to generate sufficient taxable income in the future before they expire, the company has recorded a
valuation allowance to reduce the net deferred tax asset to zero. This NOL is included in the net deferred tax asset that has been fully offset by the valuation allowance.
ASC 740 provides guidance on the financial statement recognition and measurement for uncertain income tax positions that are taken or expected to be taken in a
company’s income tax return. The Company has no uncertain tax positions as of December 31, 2014.
The Company’s federal and state tax returns for the years ended September 30, 2011 to December 31, 2013 are currently open to audit under the statutes of limitations.
There are no pending audits as of December 31, 2014.
NOTE 21. - SUBSEQUENT EVENTS
On January 14, 2015, the Company’s Board of Directors approved the Company’s Compensation Committee recommendation to award officers, employees and
directors of the Company stock awards in the form of stock options from the Company’s OIP in an aggregate amount of approximately $1,059,000. The stock options will be
granted on February 16, 2015, with an exercise price based on the average closing price of the Company’s common stock for the three trading days immediately preceding the
date of the grant.
On January 19, 2015, the Company became obligated to issue 70,423 shares of its common stock, par value $0.00001 per share, to Smoker Friendly International, LLC
(“Smoker Friendly”) under the terms of an agreement between the Company and Smoker Friendly.
F-23
Item 15 (b)
Exhibits
In reviewing the agreements included as exhibits to this report, please remember they are included to provide you with
information regarding their terms and are not intended to provide any other factual or disclosure information about the
Company, its subsidiaries or other parties to the agreements. The agreements contain representations and warranties by each of
the parties to the applicable agreement. These representations and warranties have been made solely for the benefit of the other
parties to the applicable agreement and:
•
•
should not in all instances be treated as categorical statements of fact, but rather as a way of allocating the risk to one of the
parties if those statements prove to be inaccurate;
have been qualified by disclosures that were made to the other party in connection with the negotiation of the applicable
agreement, which disclosures are not necessarily reflected in the agreement;
• may apply standards of materiality in a way that is different from what may be viewed as material to you or other investors;
and
• Were made only as of the date of the applicable agreement or such other date or dates as may be specified in the agreement
and are subject to more recent develpoments.
Accordingly, these representations and warranties may not describe the actual state of affairs as of the date they were made or at
any other time. We acknowledge that, notwithstanding the inclusion of the foregoing cautionary statements, we are responsible
for considering whether additional specific disclosures of material information regarding material contractual provisions are
required to make the statements in this report not misleading. Additional information about the Company may be found
elsewhere in this report and the Company’s other public files, which are available without charge through the SEC’s website at
http://www.sec.gov.
Exhibit No.
Description
2.1
2.2
2.3
2.4
2.5
3.1
Membership Interest Purchase Agreement between 22nd Century Group, Inc. and Ralph Angiuoli dated September 17, 2013
(incorporated by reference to Form 8-K filed with the Commission on September 17, 2013).
First Amendment to Membership Interest Purchase Agreement, dated May 13, 2014, between 22nd Century Group, Inc. and
Ralph Angiuoli (incorporated by reference to Exhibit 2.1 to the Company’s Form 8-K filed with the Commission on May 19,
2014)
Stock Purchase Agreement, dated September 17, 2014, by and between 22nd Century Group, Inc. and Crede CG III, Ltd.
(incorporated by reference to Exhibit 2.1 to the Company’s Form 8-K filed with the Commission on September 18, 2014)
Investment Agreement, dated April 11, 2014, by and between 22nd Century Group, Inc. and Anandia Laboratories Inc.
(incorporated by reference to Exhibit 2.2 to the Company’s Form 8-K filed with the Commission on September 18, 2014)
Purchase Agreement, dated December 22, 2014, by and between 22nd Century Limited, LLC and the National Research
Council of Canada (incorporated by reference to Exhibit 2.1 to the Company’s Form 8-K filed with the Commission on
December 29, 2014)
Amended and Restated Certificate of Incorporation of the Company (incorporated herein by reference to Exhibit 3.2 of the
Company’s Annual Report on Form 10-K for the year ended September 30, 2010 filed with the Commission on December 3,
2010).
3.1.1
Amendment to Certificate of Incorporation of the Company (incorporated by reference to Appendix A to the Company’s
Definitive Proxy Statement filed with the Commission on March 4, 2014)
3.2
4.1
4.2
4.3
Amended and Restated Bylaws of the Company (incorporated herein by reference to Exhibit 3.2 of the Company’s Annual
Report on Form 10-K for the year ended December 31, 2014 filed with the Commission on January 30, 2014).
Form of Warrant dated as of January 25, 2011 issued to LLC members of 22nd Century Limited, LLC prior to the
consummation of the Private Placement Offering upon consummation of the merger of 22nd Century Limited, LLC with the
Company (incorporated herein by reference to Exhibit 10.4 of the Company’s Current Report on Form 8-K filed with the
Commission on February 1, 2011).
Form of Warrant dated as of January 25, 2011 issued to investors in the Private Placement Offering upon consummation of the
merger of 22nd Century Limited, LLC with the Company (Incorporated herein by reference to Exhibit 10.5 of the Company’s
Current Report on Form 8-K filed with the Commission on February 1, 2011).
Form of Warrant dated as of January 25, 2011 issued to the Placement Agent and Sub-Agent upon consummation of the
merger of 22nd Century Limited, LLC with the Company (incorporated herein by reference to Exhibit 10.6 of the Company’s
Current Report on Form 8-K filed with the Commission on February 1, 2011).
44
4.4
4.5
4.6
4.7
4.8
4.9
4.10
10.1†
10.2†
10.3†
10.4†
10.5††
10.5.1
Form of Common Stock Purchase Warrant (incorporated herein by reference to Exhibit 4.2 of the Company’s Current Report on Form 8-K filed
with the Commission on December 14, 2011).
Form of Common Stock Purchase Warrant (incorporated herein by reference to Exhibit 4.1 of the Company’s Current Report on Form 8-K filed
with the Commission on May 18, 2012).
Form of Common Stock Purchase Warrant (incorporated herein by reference to Exhibit 4.1 of the Company’s Current Report on Form 8-K filed
with the Commission on November 13, 2012).
Form of Tranche 1A Warrant (incorporated by reference to Exhibit 4.1 to the Company’s Form 8-K filed with the Commission on September
30, 2014)
Form of Tranche 1B Warrant (incorporated by reference to Exhibit 4.2 to the Company’s Form 8-K filed with the Commission on September
30, 2014)
Form of Tranche 2 Warrant (incorporated by reference to Exhibit 4.3 to the Company’s Form 8-K filed with the Commission on September 30,
2014)
Form of Tranche 3 Warrant (incorporated by reference to Exhibit 4.4 to the Company’s Form 8-K filed with the Commission on September 30,
2014)
2010 Equity Incentive Plan (incorporated herein by reference to Exhibit 4.3 to the Company’s Form S-8 filed with the Commission on March
30, 2011).
Employment Agreement dated as of January 25, 2011 by and between the Company and Joseph Pandolfino (incorporated herein by reference to
Exhibit 10.15 of the Company’s Current Report on Form 8-K filed with the Commission on February 1, 2011).
Employment Agreement dated as of January 25, 2011 by and between the Company and Henry Sicignano III (incorporated herein by reference
to Exhibit 10.16 of the Company’s Current Report on Form 8-K filed with the Commission on February 1, 2011).
Employment Agreement dated as of March 15, 2011 by and between the Company and Michael R. Moynihan (incorporated by reference to
Exhibit 10.18 to the Company’s Form S-1 registration statement filed with the Commission on June 6, 2011).
License Agreement dated March 6, 2009 between North Carolina State University and 22nd Century Limited, LLC (incorporated by reference
to Exhibit 10.21 to the Company’s Form S-1 registration statement filed with the Commission on August 26, 2011).
Amendment dated August 9, 2012 to License Agreement dated March 6, 2009 between North Carolina State University and 22nd Century
Limited, LLC (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Commission on August
20, 2012).
10.6††
License Agreement dated May 1, 2009 between The National Research Council of Canada and 22nd Century Limited, LLC (incorporated by
reference to Exhibit 10.22 to the Company’s Form S-1 registration statement filed with the Commission on August 26, 2011).
10.7
10.8†
10.9†
10.10†
10.11††
10.12 †
10.13 †
10.14 †
10.15 †
10.16
10.17
Letter Agreement between the Company and North Carolina State University dated November 22, 2011 (incorporated by reference to Exhibit
10.1 to the Company’s Form 8-K filed with the Commission on November 23, 2011).
Employment Agreement between John Brodfuehrer and the Company dated March 19, 2013 (incorporated by reference to Form 8-K filed on
March 25, 2013).
Form of Restricted Stock Award Agreement (incorporated by reference to Form 10-Q filed on May 10, 2013).
Form of Stock Option Award Agreement (incorporated by reference to Form 10-Q filed on May 10, 2013).
Research License and Commercial Option Agreement with British American Tobacco (Investments) Limited dated October 1, 2013
(incorporated by reference to Exhibit 10.12 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2014 filed with
the Commission on January 30, 2014).
22nd Century Group, Inc. 2014 Omnibus Incentive Plan (incorporated by reference to Appendix B to the Company’s Definitive Proxy
Statement filed with the Commission on March 4, 2014)
Form of Restricted Stock Award Agreement under 22nd Century Group, Inc. 2014 Omnibus Incentive Plan (incorporated by reference to
Exhibit 10.2 to the Company’s Form 8-K filed with the Commission on April 14, 2014)
Form of Stock Option Award Agreement under 22nd Century Group, Inc. 2014 Omnibus Incentive Plan (incorporated by reference to Exhibit
10.3 to the Company’s Form 8-K filed with the Commission on April 14, 2014)
Employment Agreement dated May 12, 2014 by and between the Company and Thomas James (incorporated by reference to Exhibit 10.1 to the
Company’s Form 8-K filed with the Commission on May 14, 2014)
Registration Rights Agreement, dated September 17, 2014, by and between 22nd Century Group, Inc. and Crede CG III, Ltd. (incorporated by
reference to Exhibit 10.1 to the Company’s Form 8-K filed with the Commission on September 18, 2014)
Consulting Agreement, dated September 29, 2014, by and between 22nd Century Group, Inc., Crede CG III, Ltd. and Terren Peizer
(incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed with the Commission on September 30, 2014)
45
21.1*
23.1*
31.1*
31.2*
32.1*
101*
101.INS
101.SCH
101.CAL
101.DEF
101.LAB
101.PRE
Subsidiaries
Consent of Freed Maxick CPAs, P.C.
Section 302 Certification
Section 302 Certification
Written Statement of Principal Executive Officer and Chief Financial Officer pursuant to 18.U.S.C §1350
Interactive data files formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated
Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Cash Flows,
and (iv) the Notes to the Consolidated Financial Statements.
XBRL Instance Document*
XBRL Taxonomy Extension Schema Document*
XBRL Taxonomy Extension Calculation Linkbase Document*
XBRL Taxonomy Extension Definition Linkbase Document*
XBRL Taxonomy Extension Label Linkbase Document*
XBRL Taxonomy Extension Presentation Linkbase Document*
*Filed herewith.
† Management contract or compensatory plan, contract or arrangement.
†† Certain portions of the exhibit have been omitted pursuant to a confidential treatment order. An unredacted copy of the exhibit has
been filed separately with the United States Securities and Exchange Commission pursuant to the request for confidential treatment.
46
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly authorized.
SIGNATURES
Date:
February 5, 2015
Date:
February 5, 2015
By:
By:
22nd CENTURY GROUP, INC.
/s/ Henry Sicignano, III
Henry Sicignano, III
President, Chief Operating Officer and Director
(Principal Executive Officer)
/s/ John T. Brodfuehrer
John T. Brodfuehrer
Chief Financial Officer
(Principal Accounting and Financial Officer)
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date:
February 5, 2015
Date:
February 5, 2015
Date:
February 5, 2015
Date:
February 5, 2015
Date:
By:
By:
By:
By:
By:
/s/ Henry Sicignano III
Henry Sicignano III
President, Chief Operating Officer and Director
/s/ Joseph Alexander Dunn, Ph.D.
Joseph Alexander Dunn, Ph.D.
Director
/s/ James W. Cornell
James W. Cornell
Director
/s/ Richard M. Sanders
Richard M. Sanders
Director
Joseph Pandolfino
Director
47
SUBSIDIARIES OF
22nd CENTURY GROUP, INC.
EXHIBIT 21.1
NAME
22nd Century Limited, LLC
Goodrich Tobacco Company, LLC
Hercules Pharmaceuticals, LLC
NASCO Products, LLC
Botanical Genetics, LLC
22nd Century Asia Ltd.
STATE OF
FORMATION
PERCENTAGE
OWNERSHIP
Delaware
Delaware
Delaware
North Carolina
Delaware
Bermuda
100%
100%
100%
100%
100%
51%
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in Registration Statement Numbers 333-173166 and 333-195380 on Form S-8 and in
Registration Statement Numbers 333-195386 and 333-199273 on Form S-3 of 22nd Century Group, Inc. of our report, dated February 5,
2015, on the consolidated financial statements as of and for the years ended December 31, 2014 and 2013, appearing in this Annual
Report on Form 10-K of 22nd Century Group, Inc.
EXHIBIT 23.1
/s/ Freed Maxick CPAs, P.C.
Buffalo, NY
February 5, 2015
CERTIFICATIONS
EXHIBIT 31.1
I, Henry Sicignano, III, President and Chief Operating Officer of 22nd CENTURY GROUP, INC., certify that:
1.
2.
3.
4.
I have reviewed this annual report on Form 10-K of 22nd CENTURY GROUP, INC.;
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading
with respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods
presented in this report;
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as
defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a.
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed
under our supervision, to ensure that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly during the period in which this report
is being prepared;
b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and
the preparation of financial statements for external purposes in accordance with generally accepted accounting
principles;
c.
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by
this report based on such evaluation; and
d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during
the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that
has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial
reporting.
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over
financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing
equivalent functions):
a.
All significant deficiencies and material weaknesses in the design or operation of internal control over financial
reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and
report financial information; and
b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrant’s internal control over financial reporting.
Date: February 5, 2015
/s/ Henry Sicignano, III
Henry Sicignano, III
President and Chief Operating Officer
(Principal Executive Officer)
I, John T. Brodfuehrer, Chief Financial Officer of 22nd CENTURY GROUP, INC., certify that:
CERTIFICATIONS
EXHIBIT 31.2
1.
2.
3.
4.
I have reviewed this annual report on Form 10-K of 22nd CENTURY GROUP, INC.;
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading
with respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods
presented in this report;
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as
defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a.
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed
under our supervision, to ensure that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly during the period in which this report
is being prepared;
b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and
the preparation of financial statements for external purposes in accordance with generally accepted accounting
principles;
c.
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by
this report based on such evaluation; and
d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during
the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that
has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial
reporting.
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over
financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing
equivalent functions):
a.
All significant deficiencies and material weaknesses in the design or operation of internal control over financial
reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and
report financial information; and
b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrant’s internal control over financial reporting.
Date: February 5, 2015
/s/ John T. Brodfuehrer
John T. Brodfuehrer
Chief Financial Officer
(Principal Financial Officer)
Written Statement of the Chief Executive Officer and Chief Financial Officer
Pursuant to 18 U.S.C. §1350
EXHIBIT 32.1
Solely for the purposes of complying with 18 U.S.C. §1350, I, the undersigned President and Chief Operating Officer of 22nd CENTURY
GROUP, INC. (the “Company”), and I, the undersigned Chief Financial Officer of the Company, hereby certify, to the best of my
knowledge, that the annual report on Form 10-K of the Company for the year ended December 31, 2014 (the “Report”) fully complies
with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934 and that the information contained in the
Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
This certification is being furnished solely to accompany this Report pursuant to 18 U.S.C. 1350, and is not being filed for purposes of
Section 18 of the Securities Exchange Act of 1934 and is not to be incorporated by reference into any filing of the registrant, whether
made before or after the date hereof, regardless of any general incorporation language in such filing.
Date: February 5, 2015
/s/ Henry Sicignano, III
Henry Sicignano, III
President and Chief Operating Officer
Date: February 5, 2015
/s/ John T. Brodfuehrer
John T. Brodfuehrer
Chief Financial Officer
22nd Century Group, Inc.
Dear Fellow Shareholders:
As expected, 2014 represented a
period of transition for 22nd Century
Group. From our inception, the
Company focused primarily on
research and development. Since
the latter part of last year, however,
we recast our priorities to instead
concentrate our efforts on monetizing
our exceptional intellectual property
portfolio.
Coinciding with this change, in March 2015, our Board of
Directors appointed me Chief Executive Officer. I am honored
and tremendously excited to have been chosen to lead the
Company at this momentous time in our history.
Our technology is extraordinary. Our management team is
exceptional. Our mission is noteworthy. Indeed, in my new
position, I have reemphasized our core mission: to reduce
the harm caused by smoking. In pursuit of this important
goal, we intend to help millions of consumers who will use our
products… and, at the same time, provide substantial value to our
shareholders.
22nd Century is in the rare position of having a virtual monopoly
around the nicotine biosynthetic pathway in the tobacco plant.
To capitalize on this extraordinary asset we have articulated the
Company’s most important priorities as follows:
1) Pursuit of FDA authorization for our BRAND A modified
risk cigarettes in development;
2) Contracting with a suitable joint venture partner to
fund and conduct a Phase III clinical trial for X-22, the
Company’s tobacco-based smoking cessation aid in
development;
3) Obtaining substantial, multi-year sales contracts in Asia
for our proprietary tobacco products;
4) Commercialization of RED SUN® super-premium
cigarettes in the U.S.;
5) Launching MAGIC® very low nicotine cigarettes in Europe,
starting with Spain in the latter part of March 2015; and
6) Establishing a base of third-party contract manufacturing
business at our NASCO manufacturing facility.
The Company’s very low nicotine BRAND A modified risk
candidate is exactly consistent with what public health officials
have long sought:
“The FDA should quickly move to reduce nicotine levels in cigarettes
to non-addictive level. If we reduce the level of the stimulus, we
reduce the craving. It is the ultimate harm reduction strategy.”
Dr. David Kessler, Former FDA Commissioner
June 16, 2010
There could be no stronger endorsement – from a more influential
public health official – than Dr. Kessler’s definition of “the
ultimate harm reduction strategy.” As the only company in
the world capable of producing tobacco cigarettes – without
extraction – with 95% less nicotine than conventional cigarettes,
22nd Century is in the unique position of being able to achieve
precisely what Dr. Kessler envisions. To this end, we look forward
to submitting our application to the FDA later this year for our very
low nicotine BRAND A modified risk cigarettes in development.
Also utilizing our proprietary very low nicotine (VLN) tobacco,
our X-22 smoking cessation aid in development is another
strategic imperative for the Company. We hope to announce a
joint venture partner later this year to fund our Phase III clinical
trial and to help us commercialize X-22. There is good reason
for us to be enthusiastic about X-22: There have been five
independent Phase II clinical trials – and one independent Phase
III clinical trial – that have utilized cigarettes made from 22nd
Century’s proprietary tobacco (treating 2,438 total smokers);
in all 6 independent trials, VLN cigarettes increased quit rates.
Indeed, our VLN cigarettes are in a unique position in that there
is evidence in clinical studies demonstrating: (i) VLN cigarettes
work by themselves, (ii) VLN cigarettes increase the efficacy
of nicotine replacement therapy products (patch, gums and
lozenges), and (iii) VLN cigarettes increase the efficacy of Pfizer’s
Chantix®. The smoking cessation market is a multi-billion dollar
industry and securing even a small portion of that market would
be quite significant for our Company. To this end, the approval of
X-22 by the FDA would be monumental for our Company and our
shareholders.
We also intend to continue to pursue potential joint ventures
and other business opportunities in Asia. To further facilitate
22nd Century’s business opportunities in Asia, I will be making
additional trips to Asia in 2015. I am optimistic that we will be able
to announce one or more business contracts with Asian partners
in 2015.
An important step along 22nd Century’s path to commercialization
occurred when our Company became a subsequent participating
member of the U.S. tobacco Master Settlement Agreement
(MSA). Through our acquisition of NASCO Products, LLC, we
were the first company in more than six years to become a
new signatory to the MSA. As a result of this very important
achievement, the Company began the process of listing its super-
premium brand, RED SUN,® on the state tobacco directories of
approved products across the United States. We have received
approvals from 42 states already and we expect to gain approval
from the remaining states very soon.
Our Company also continues to move forward with efforts to
launch our MAGIC® brand of very low nicotine cigarettes in
Europe and Asia. Our Company’s contract cigarette manufacturer
in Europe has begun production of our MAGIC® brand for a
product launch in Spain planned for the latter part of March 2015.
We have already received preorders from several hundred stores
in Spain, the MAGIC® website is nearly complete, and we are
increasingly excited about the prospects of MAGIC® in Spain and
in other parts of Europe.
Looking ahead, our prospects have never been better. We are
intensely focused on the business drivers which will make the
biggest differences for our Company and our shareholders. On
behalf of the 22nd Century Group management team, we thank
you for being part of our family of shareholders; we look forward
to keeping you apprised of our exciting commercialization
achievements in the months to come.
Best regards,
Henry Sicignano III
Chief Executive Officer, President
& Director
CORPORATE HEADQUARTERS
EXECUTIVE OFFICERS
Annual Meeting Notice
22nd Century Group, Inc.
9530 Main Street
Henry Sicignano III
President & CEO
Clarence, NY 14031
(716) 270-1523
xxiicentury.com
Investor Relations
Redington, Inc.
49 Richmondville Ave.
Westport, CT 06880
Phone: 203-222-7399
Fax: 203-222-1819
Legal Counsel
Foley & Lardner LLP
3000 K Street, NW
6th Floor
Washington, DC 20007
Phone: 202-672-5300
Fax: 202-672-5399
Auditors
Freed Maxick CPA’s, PC
Liberty Building, Suite 800
424 Main Street
Buffalo, NY 14202-3508
Phone: 716-847-2651
Fax: 716-847-0069
Transfer Agent
Continental Stock and
Transfer Company
17 Battery Place
New York, NY 10004
Phone: 212-509-4000
Fax: 212-509-5150
The Annual Meeting
of Shareholders:
Saturday, April 25, 2015
2:00 p.m.
The Buffalo Club
388 Delaware Avenue
Buffalo, NY 14202
John T. Brodfuehrer
Chief Financial Officer
Thomas L. James, Esq.
Vice President, General Counsel
& Secretary
Stockholder Information
Michael Moynihan, Ph.D.
Vice President of R&D
DIRECTORS
Henry Sicignano III
President & CEO
Requests for interim reports
(Form 10-Q) and annual reports
(Form 10-K) and requests for
more information about the
Company should be directed
in writing to:
Joseph Alexander Dunn, Ph.D.
Associate Dean for Research
22nd Century Group, Inc.
Attn: Chief Financial Officer
9530 Main Street
and Professor of Pharmaceutical
Clarence, NY 14031
Press releases and Securities and
Exchange Commission filings are
available by visiting our website at
www.xxiicentury.com
Sciences, D’Youville College
of Pharmacy
James W. Cornell
President and CEO
Praxiis, LLC
Richard M. Sanders
Partner
Phase One Ventures, LLC
Joseph Pandolfino
Founder
2014 Annual Report Cover.indd 2
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2014 ANNUAL REPORT
2014 ANNUAL REPORT
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22nd Century Group, Inc.
9530 Main Street
Clarence, New York 14031
Telephone: (716) 270-1523
Fax: (716) 877-3064
xxiicentury.com
© 22nd Century Group, Inc.
Innovative Cigarettes
for those who enjoy smoking
Groundbreaking Smoking Cessation
Product in Development
for those who wish to quit
The material in this presentation is provided for the purpose of giving information about
22nd Century Group to investors and is not provided for tobacco product advertising,
promotional, or marketing purposes. This material does not constitute and should not
be construed as constituting an offer to sell, or a solicitation of an offer to buy, any of
our tobacco products.
2014 Annual Report Cover.indd 1
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