Our Potential 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.

TheTobacco 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.

TheTobacco 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, (ii) the available scientific evidence demonstrates that it is reasonably likely that subsequent studies will show substantially lower health risks in those who use the product, as compared to conventional cigarettes, and (iii) introduction is expected to benefit the health of the population as a whole taking into account both users of tobacco products and persons who do not currently use tobacco products (“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 which could create opportunities for us to license our proprietary technology and/or our tobaccos to larger competitors.