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XXII > SEC Filings for XXII > Form 10-Q on 12-Nov-2013All Recent SEC Filings

Show all filings for 22ND CENTURY GROUP, INC.

Form 10-Q for 22ND CENTURY GROUP, INC.


12-Nov-2013

Quarterly Report


NOTE 2. - LIQUIDITY, LICENSE AGREEMENT AND MANAGEMENT'S PLANS

At September 30, 2013, the Company had current assets of $2,394,639 and current liabilities of $2,206,627, resulting in positive working capital of $188,012. Cash on hand at September 30, 2013 was $1,035,767. The Company has improved its balance sheet and cash position primarily through a series of transactions that realized net proceeds of approximately $4.290 million during the nine months ended September 30, 2013, consisting of: (1) $2,035,000 in January 2013, through the sale of preferred shares, (2) $1,150,000 during June and July 2013, from the exercise of Series B Warrants into shares of common stock, (3) $940,000 in August 2013, from the exercise of Series C Warrants into shares of common stock, and (4) $165,000 in August 2013, from the exercise of warrants issued in conjunction with the May 15, 2012 Private Placement. In addition, during January 2013, convertible notes with a carrying value at December 31, 2012 of approximately $1,409,000 were converted into shares of common stock and in August 2013, convertible notes with a carrying value at June 30, 2013 of approximately $223,000 were converted into shares of common stock.

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 $7,000,000. In addition, the Company may receive payments from BAT of up to an additional $7,000,000 during the research term upon the completion of four developmental milestones, $1.5 million for each of 2 milestones and $2 million for each of two additional milestones. The research term of the Agreement is for a period of up to four (4) years during which time 22nd Century Ltd's and BAT will collaborate on research efforts to further develop the subject technology. Pursuant to the Agreement, BAT can exercise its option to enter into a worldwide royalty-bearing commercial license at any time during the research term. The Agreement is more fully explained in Note 15.

The Company used approximately $1.380 million of the proceeds to pay off notes payable, accrued interest on the notes payable, and accrued expenses in the fourth quarter of 2013. A portion of the patented technology sublicensed to BAT is exclusively licensed to 22nd Century Ltd by a third party licensor. Pursuant to the terms of the license agreement with such licensor, 22nd Century Ltd is obligated to make a royalty payment to the licensor. 22nd Century Ltd estimates the payment to be approximately $414,000, subject to the mutual consent of 22nd Century Ltd and the third party licensor. In addition, approximately $200,000 and $3,070,000 may be required to close the NASCO transactions and fund the purchase of various cigarette manufacturing equipment, respectively, as described below and more fully in Note 12.

Goodrich Tobacco received a purchase order from RTI in September 2013 to supply an additional 5.5 million SPECTRUM research cigarettes to NIDA in the fourth quarter of 2013. The order is expected to provide the Company with gross proceeds of approximately $448,000, $179,000 of which has been received in October 2013 as a deposit. The SPECTRUM order is expected to be shipped to the FDA in December 2013. In addition, Goodrich Tobacco was chosen to be a subcontractor under a government contract between RTI and the U.S. Food and Drug Administration (the "FDA") to supply very low nicotine ("VLN") fine cut tobacco to the FDA. The tobacco is expected to be shipped to the FDA in the fourth quarter of 2013 and result in gross proceeds to the Company in the amount of approximately $225,000.

As a result of the above referenced transactions that occurred in the fourth quarter of 2013, and considering the cash on hand as of September 30, 2013 of approximately $1,000,000, the Company believes it will have adequate cash reserves to sustain operations and meet all current obligations as they come due for a period in excess of 12 months.

The Company plans to become a participating manufacturer of the Master Settlement Agreement ("MSA"), a settlement among 46 U.S. states and the tobacco industry administered by the National Association of Attorneys General ("NAAG"), to produce its RED SUN, MAGIC and SPECTRUM brands and other brands for export. To this end, the Company is following two parallel tracks for becoming a member of the MSA. In January 2013, Goodrich Tobacco applied to the Alcohol and Tobacco Tax Trade Bureau ("TTB") for a federal permit to manufacture its own tobacco products. Being a federally licensed tobacco product manufacturer is a primary requirement of becoming a participating manufacturer of the MSA. On February 26, 2013, Goodrich Tobacco applied to the NAAG to become a participating manufacturer to the MSA. To date, the TTB permit has not been obtained.

Additionally, on September 17, 2013, the Company entered into a Membership Interest Purchase Agreement to purchase all of the issued and outstanding membership interests of NASCO Products, LLC ("NASCO"), a North Carolina limited liability company ("NASCO") (the "NASCO Transaction"). NASCO already has a TTB permit to manufacture its own tobacco products and is a participating member of the MSA. Consummation of the NASCO Transaction is subject to various conditions including required consents and authorizations from NAAG and certain attorneys general. The NASCO Transaction contains termination rights, including a right for the Company to terminate the Purchase Agreement if the closing shall not have occurred on or before January 31, 2014.

If the Company is successful through one of these two parallel tracks to become a licensed tobacco products manufacturer and a participating member of the MSA, the successful track will facilitate the sales and distribution potential of RED SUN and MAGIC in the U.S. Until now, sales and marketing of the Company's commercial cigarettes have been curtailed in order to limit the settlement costs associated with Goodrich Tobacco becoming a participating manufacturer of the MSA; the more RED SUN and MAGIC that is sold while being produced by a non-participating manufacturer, the greater settlement cost Goodrich Tobacco likely has to pay to become a participating manufacturer of the MSA and the more complex the process becomes. The Company expects its initial cigarette factory capital requirements to be approximately $3 million (see Note 12). The costs associated with the MSA settlement are expected to be less than $40,000.

NOTE 3. - 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.

The shares of Series A-1 Preferred Stock were initially convertible into a total of 4,166,666 shares of the Company's common stock at a conversion price of $0.60 per share (the "Conversion Price"), subject to future adjustments, which have subsequently expired with no change to the conversion price. The Series A-1 Preferred Stock paid a 10.0% annual cash dividend, which was payable in shares of our common stock in certain circumstances, and had a liquidation preference equal to the stated value of the Series A-1 Preferred Stock of $1,000 per share plus any accrued and unpaid dividends thereon. The Series A-1 Preferred Stock had no voting rights.

The preferred stockholders did not have mandatory redemption rights, nor did the Company have an unconditional obligation to issue a variable number of shares. Further, there was a limit on the number of shares that were issuable upon conversion. Accordingly, the Series A-1 Preferred Stock was classified as permanent equity. Based on the fact that the host instrument is more akin to equity, it was further determined that bifurcation of the embedded conversion feature was not required.

The Company also issued to the Purchasers of the Series A-1 Preferred Stock a Series A warrant (the "Series A Warrant"), a Series B warrant (the "Series B Warrant"), and a Series C warrant (the "Series C Warrant") (with the Series A Warrant, Series B Warrant and Series C Warrant being collectively referred to herein as the "Warrants"). The Series A Warrant allows the Purchasers the right to acquire, initially before any adjustments to the conversion price, up to an additional 4,166,666 shares of the Company's common stock at an exercise price of approximately $0.72 per share over a period of five (5) years. The Series A Warrant also allows for such warrant to be exercised on a cashless basis. The Series B Warrant allowed the Purchasers a one-year period to exercise an overallotment option as contained in the Series B Warrant to purchase, initially before any adjustments to the conversion price, up to an additional aggregate of 2,083,334 shares of the Company's common stock at a price of $0.60 per share. Since the Purchasers fully exercised the Series B Warrant, the Purchasers have the right to exercise the Series C Warrant to acquire, initially before any adjustments to the conversion price, an additional aggregate of 2,083,334 shares of the Company's common stock at an exercise price of approximately $0.72 per share over a period of five (5) years. The Series C Warrant allows for such warrant to be exercised on a cashless basis.

The warrants have a "down round provision" which results in the warrants being classified and reported as derivative liabilities for accounting purposes and marked to market at each balance sheet date. At the date of the issuance of these warrants, including lock-up warrants, the fair value was estimated to be $6,022,319, which exceeded the net consideration received in the offering of $2,034,664, resulting in an immediate charge to "other expense - warrant liability change - net" in the amount $3,987,655. During June 2013, 982,300 Series B Warrant shares were exercised resulting in net proceeds to the Company in the amount of $542,229. In addition, the exercise of the Series B Warrant shares resulted in a reduction in the warrant liability and an increase in capital in the amount of $204,513. The exercise of the 982,300 Series B Warrant shares triggered the issuance of a like amount of Series C Warrant shares. The Series C Warrant shares include a "down round provision" and results in a derivative liability upon issuance. At the date of issuance of the 982,300 Series C Warrant shares the fair value was estimated to be $711,675. During July 2013, 1,101,034 Series B Warrant shares were exercised resulting in net proceeds to the Company in the amount of $607,771. In addition, the exercise of the Series B Warrant shares resulted in a reduction in the warrant liability and an increase in capital in the amount of $671,219. The exercise of the 1,101,034 Series B Warrant shares triggered the issuance of a like amount of Series C Warrant shares. The Series C Warrant shares include a "down round provision" and results in a derivative liability upon issuance. At the date of the issuance of these warrants the fair value was estimated to be $1,622,069, which exceeded the sum of the net consideration received in the offering of $607,771 and the reclassification of warrant liability to capital of $671,219, resulting in an immediate charge to "other expense - warrant liability change - net" in the amount of $343,079.

As of June 30, 2013, the Company accrued a dividend payable to the preferred shareholders in the amount of $93,361. On May 9, 2013 the Company executed an agreement with the Purchasers of the Series A-1 Preferred Shares to pay certain accrued dividends on the Series A-1 Preferred Stock in shares of the Company's common stock in lieu of cash. In accordance with the agreement, on July 12, 2013, the Company issued 161,153 shares of common stock to the Purchasers of the Series A-1 Preferred Shares in payment of the accrued dividends payable at June 30, 2013, resulting in an increase in capital in the amount of $93,361. No dividends are accrued or payable subsequent to the payment of this dividend.

On August 1, 2013, the Company entered into a Warrant Exercise Agreement with the holders of its Series A Warrants and Series C Warrants for such holders to exercise a portion of such Series C Warrants to acquire an aggregate of 1,666,666 shares of the Company's common stock for a cash payment to the Company of $1,000,000. Prior to the Company and such holders of the Series A Warrants and the Series C Warrants entering into such Warrant Exercise Agreement, the Series A Warrants and the Series C Warrants could have been exercised by such holders on an entirely cashless basis. In exchange for the cash exercise of such portion of the Series C Warrants, the Company reduced the exercise price of all of the Series A Warrants and Series C Warrants from $0.72 to $0.60 per share. The reduced exercised price resulted in an increase in the warrant liability associated with the Series A Warrants and Series C Warrants and a corresponding reduction in capital in the amount of $626,328. In addition, if on a specified date in the future when the shares of common stock of the Company acquired upon this cash exercise of the Series C Warrants become freely tradable pursuant to Rule 144 of the Securities Act of 1933, as amended, the Company's common stock (as measured by the five trading days before such date) is less than $1.31 per share (the "Measurement Price"), then the Company must reimburse the holders of these warrants up to an amount equal to the difference between $1.31 and the Measurement Price (subject to a floor of $0.60 per share) multiplied by the number of shares of common stock acquired upon the cash exercise of such Series C Warrants pursuant to the terms of the Warrant Exercise Agreement (the "Limited Market Make-Good Provision"). Notwithstanding the foregoing, the Company has no obligation to pay such amounts under the Limited Market Make-Good Provision until and unless the holders of the shares actually incur a loss on the sales of such shares of common stock for a price below the Measurement Price. The Limited Market Make-Good Provision created a contingent liability that must be evaluated and recorded based on its fair value at each reporting date. The maximum exposure related to this obligation is $1,183,333. Upon entering into this agreement, management estimated the fair value of the instrument and recorded a current liability and corresponding reduction in capital of approximately $290,000 as of September 30, 2013. The Series C Warrant holders exercised the cash option on August 5, 2013. The cash exercise of these Series C Warrant shares resulted in a reduction in the warrant liability and an increase in capital in the amount of $2,426,939. As a result of this Warrant Exercise Agreement, an additional $60,000 commission was paid to Chardan Capital Markets, LLC.

On August 6, 2013, the Series A and Series C Warrant holders exercised on a cashless basis at $0.60 per share 147,916 and 416,668 Series A and Series C Warrant shares, respectively, resulting in the issuance of 360,000 shares of common stock of the Company. The cashless exercise of these Series A and Series C Warrant shares resulted in a reduction in the warrant liability and an increase in capital in the amount of $888,336. On September 20, 2013, the Series A Warrant holders exercised on a cashless basis at $0.60 per share 339,861 Series A Warrants resulting in the issuance of 177,300 shares of common stock of the Company. This cashless exercise of these Series A Warrant shares resulted in a reduction in the warrant liability and an increase in capital in the amount of $642,554.

In connection with the issuance of the Series A-1 Preferred Stock, the Company paid Chardan Capital Markets, LLC a commission equal to (i) ten percent (10%) of the cash received by the Company and (ii) 416,666 shares of common stock. In the event the Purchasers exercise for cash any of the Warrants, then the Company will also pay an additional cash commission to Chardan Capital Markets LLC equal to eight percent (8%) (with no additional equity) of any such additional cash amounts received by us. For the nine months ended September 30, 2013, the Company paid an aggregate total of $160,000 in commissions to Chardan Capital Markets, LLC in conjunction with the cash exercise of Series B and Series C Warrant shares.

In conjunction with the Series A-1 Preferred Stock private placement, the Company issued 203,167 lock-up warrants to stockholders that participated in previous private placements. These warrants were valued at $168,402 and are considered liabilities due to a down round provision. This amount was also considered a cost of the Series A-1 Preferred Stock private placement. After deducting fees and expenses, the aggregate net proceeds from the sale of the Series A-1 Preferred Shares and the Warrants were $2.035 million. The net proceeds were earmarked for the payment of certain financial obligations and for working capital and other general corporate purposes.

NOTE 4. - MAY 2012 AND NOVEMBER 2012 PRIVATE PLACEMENTS

On May 15, 2012, the Company issued 1,710,833 shares of its common stock and warrants to purchase up to 1,710,833 shares of its common stock for total consideration of $1,026,500 consisting of the following: $786,500 in cash, cancellation by a vendor of $150,000 in accounts payable and the exchange by an employee of his 4% minority interest in Goodrich Tobacco for stock and warrants valued at $90,000 in the offering. The warrants issued have an original exercise price of $1.00 per share, a five year term and a "down round provision," which results in the warrants being classified and reported as derivative liabilities for accounting purposes, and marked to market at each balance sheet date. At the date of issuance of these warrants, the value was estimated to be $1,841,000 which exceeded the total consideration received in the offering by $814,500 resulting in an immediate charge to "other income and expense - warrant liability - net" for this amount. This private placement constituted a "down round" for purposes of all previously issued warrants and the December 14, 2011 Convertible Notes and resulted in adjustments to the exercise price, conversion price and the number of shares issuable upon exercise or conversion of these previously issued securities. Three executive officers of the Company acquired 44,000 shares and warrants for $26,400 in cash.

On November 9, 2012, the Company issued 3,238,000 shares of its common stock and warrants to purchase up to 1,619,000 shares of its common stock for total consideration of $809,500 consisting of the following: $681,000 in cash, cancellation by vendors of $98,500 in accounts payable, and cancellation of $30,000 in directors fees owed to two members of the board of directors. The warrants issued have an original exercise price of $1.00 per share, a five year term and a "down round provision," which results in the warrants being classified and reported as derivative liabilities for accounting purposes, and marked to market at each balance sheet date. At the date of issuance of these warrants the value was estimated to be $353,747 which reduced the amount recorded to additional paid in capital. This private placement constituted a "down round" for purposes of all previously issued warrants and the December 14, 2011 Convertible Notes and resulted in adjustments to the exercise price, conversion price and the number of shares issuable upon exercise or conversion of these previously issued securities. Two executive officers of the Company acquired 1,080,000 shares and 540,000 warrants for $270,000 in cash. Two directors of the Company acquired 120,000 shares and 60,000 warrants in lieu of payment of $30,000 of director fees.

NOTE 5. - AMOUNTS OWED NORTH CAROLINA STATE UNIVERSITY ("NCSU")

The Company is currently in full compliance with the NCSU license agreement. Pursuant to the terms of an exclusive license agreement with NCSU, the Company owed NCSU approximately $555,000 as of September 30, 2013 for patent costs and license fees (as compared to $873,000 owed as of December 31, 2012). These amounts are included in accounts payable, notes payable and accrued liabilities at September 30, 2013 and accounts payable and accrued liabilities at December 31, 2012 in the consolidated balance sheets. The Company was required to pay these amounts within thirty days of being invoiced and they were past due. NCSU had the right to claim interest on the balance. Management periodically communicates its plans for commercialization of products using the technology licensed from NCSU. As of September 30, 2013, patent costs associated with the exclusive license agreements had a carrying value of approximately $784,000. Additionally, NCSU had not imposed interest charges on past due amounts invoiced to the Company and as such the Company has not recorded accrued interest or interest expense.

In January 2013, the Company paid NCSU $400,000 and issued a note dated February 1, 2013 for $474,893. The note was unsecured, bears interest at 5% per annum and matures the earlier of October 1, 2013 or the closing of a licensing agreement with up front proceeds of at least $1.5 million. NCSU also agreed not to invoke rights to terminate the Company's license agreement for nonpayment or nonperformance, if any, until October 1, 2013. On October 2, 2013, the Company paid $490,701 to NCSU in full satisfaction of the note plus all accrued interest, leaving a balance due to NCSU in accounts payable of approximately $64,000.

NOTE 6. - DEMAND BANK LOAN

The demand loan that is among the Company's short term liabilities is payable to a commercial bank under a revolving credit agreement and is guaranteed by an officer of the Company. This loan had a balance of $174,925 at September 30, 2013 and December 31, 2012. The Company is required to pay interest monthly at an annual rate of 0.75% above the prime rate, or 4.00% at September 30, 2013 and December 31, 2012. 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 the Company's assets.

NOTE 7. - NOTES PAYABLE

Notes payable consisted of the following as of the dates set forth below:

                                                September 30,     December 31,
                                                    2013              2012

Note dated March 31, 2011                      $             -   $       77,000
Note dated January 25, 2011                            140,000          140,000
Note dated March 13, 2013 and March 30, 2011           175,000          350,000
Note dated March 22, 2012 and April 13, 2012                 -           50,000
Note dated January 15, 2013                            136,671                -
Note dated January 23, 2013                            150,000                -
Note dated January 24, 2013                                  -                -
Note dated February 1, 2013                            474,893                -

Notes Payable (shown in current liabilities)   $     1,076,564   $      617,000

Convertible Note Dated March 31, 2011 (unsecured) - On March 31, 2011, the Company issued a note to a vendor in the original amount of $237,000 as satisfaction of past due invoices previously recorded by the Company in accounts payable. The note bears interest at an annual rate of 9%. In December 2011 the note was amended and the principal was reduced by a cash payment of $50,000 and $100,000 of the notes was exchanged for $115,000 of a portion of the Convertible Notes issued December 14, 2011. The Company made a $10,000 principal payment in May 2012, leaving a remaining balance of $77,000 as of December 31, 2012. On January 18, 2013 the note was paid in full together with accrued interest.

Note Dated January 25, 2011 (unsecured) - On January 25, 2011, the Company issued a note for $140,000 to a shareholder as satisfaction of the balance due for principal and interest on a matured note that was not paid in cash or converted to common stock of 22nd Century Group and warrants to purchase shares of common stock of 22nd Century Group. The note bears interest at 12% and is due on October 1, 2013 together with accrued interest. As of September 30, 2013 and December 31, 2012, the outstanding principal amount of this note is $140,000. In July 2013, the Company made a $30,000 payment that was applied to the accrued interest on the note. On October 2, 2013, the Company made a payment to the note holder in the amount of $155,153 in full satisfaction of the note and all accrued interest.

Note Dated March 13, 2013 and March 30, 2011 (unsecured) - On March 30, 2011, the Company issued a note to a vendor in the amount of $350,000 as satisfaction of past due invoices previously recorded by the Company in accounts payable. The note bears interest at an annual rate of 4%. Principal and accrued interest were due on July 1, 2012. As of December 31, 2012, the outstanding principal of $350,000 on this note remained unpaid. In January 2013, the Company repaid $268,286 of the note principal. The remaining unpaid balance of $81,714 plus accrued interest of $25,582 and outstanding accounts payable of $67,704 were refinanced into a new unsecured note dated March 13, 2013, which bears interest at 5% and matures on July 1, 2014 or sooner if the Company receives license revenue or financing of at least $1,500,000 prior to maturity. The outstanding principal on this note was $175,000 as of September 30, 2013. On October 11, 2013, the Company made a payment to the note holder in the amount of $181,233 in full satisfaction of the note and all accrued interest.

Note Dated March 22, 2012 and April 13, 2012 (secured) - On March 22, 2012 and April 13, 2012, the Company issued two notes in the amount of $25,000 each, originally due on October 1, 2012. The notes were secured by all assets of the Company and its subsidiaries. An officer of the Company is the managing member of the lender. The notes bear interest at an annual rate of 15%. The outstanding principal on this note as of December 31, 2012 was $50,000. Principal and accrued interest of both notes were paid in full on January 22, 2013.

Note Dated January 15, 2013 (unsecured) - On January 15, 2013, the Company issued a note to a vendor in the amount of $226,780 as satisfaction of past due invoices previously recorded by the Company in accounts payable and accrued interest. The note bears interest at an annual rate of 8%. The outstanding principal and accrued interest is due on October 18, 2013 or sooner if the Company closes an in-licensing agreement in which the Company or a subsidiary receives an up-front payment of at least $1 million. On August 2, 2013, the Company made a $100,000 payment to the note holder that was applied against the note and accrued interest. The outstanding principal on this note as of September 30, 2013 was $136,671. On October 2, 2013, the Company made a payment to the note holder in the amount of $138,469 in full satisfaction of the note and all accrued interest.

Note Dated January 23, 2013 (unsecured) - On January 23, 2013, the Company issued a note to a shareholder and executive officer of the Company. The note bears interest at an annual rate of 15%. The outstanding principal and accrued interest was due on October 1, 2013. The outstanding principal on this note as of September 30, 2013 was $150,000. On October 2, 2013, the Company made a payment to the note holder in the amount of $165,473 in full satisfaction of the note and all accrued interest.

Note Dated January 24, 2013 (unsecured) - On January 24, 2013, the Company issued a note to a former Convertible Note holder in the amount of $58,340 to discharge $57,500 in Convertible Notes held by the lender plus accrued interest. The note bears interest at an annual rate of 15%. The outstanding principal and accrued interest was due on July 24, 2013. On July 16, 2013, the note was paid in full together with all accrued interest.

Note Dated February 1, 2013 (unsecured) - On February 1, 2013, the Company . . .

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