NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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Jun. 30, 2011
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Dec. 31, 2010
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NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
NOTE 1. - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
Introduction - These
unaudited consolidated financial statements of 22nd Century Group
Inc. (“22nd Century Group”) and its direct and indirect
subsidiaries (collectively with 22nd Century Group, the
“Company”) incorporate and reflect the reverse
acquisition of 22nd Century Limited, LLC by 22nd Century Group,
Inc. as described below.
On
January 25, 2011, 22nd Century Limited, LLC (“22nd Century
Ltd”) completed a reverse merger transaction (the
“Merger”) with 22nd Century Group, Inc. (formerly
Touchstone Mining Limited). As a result, 22nd Century Ltd became a
wholly owned subsidiary of 22nd Century Group which continues to
operate the business of 22nd Century Ltd. In connection with the
Merger, 22nd Century Group issued 21,434,446 shares of its common
stock to the holders of limited liability company membership
interests of 22nd Century Ltd, which share amount represented 80.1%
of the outstanding shares immediately following the Merger. All
references contained herein to shareholders or common shares
include the historical members and limited liability company
membership interests of 22nd Century Ltd because, in the Merger,
limited liability company membership interests were exchanged for
common shares on a one-for-one basis and from an accounting
standpoint they are equivalent.
The
Merger is being accounted for as a reverse acquisition and a
recapitalization; 22nd Century Ltd is the acquirer for accounting
purposes. Consequently, the assets and liabilities and the
historical operations that are reflected in the financial
statements set forth herein for periods prior to the Merger are
those of 22nd Century Ltd and are recorded at the historical cost
basis of 22nd Century Ltd, and the consolidated financial
statements set forth herein for periods beginning on and following
completion of the Merger include the assets and liabilities of 22nd
Century Ltd, historical operations of 22nd Century Ltd, and
operations of 22nd Century Group from the closing date of the
Merger.
Upon
the closing of the Merger, 22nd Century Group transferred all of
its operating assets and liabilities to Touchstone Split Corp. and
split-off Touchstone Split Corp. through the sale of all of the
outstanding capital stock of Touchstone Split Corp. (the
“Split-Off”). After the completion of the Merger and
Split Off, 22nd Century Group’s consolidated financial
statements include only the assets and liabilities of 22nd Century
Ltd. Refer to the Current Report on Form 8-K that the
Company filed with the Securities and Exchange Commission on
February 1, 2011 for further information on the
Merger.
Immediately
prior to the Merger on January 25, 2011, 22nd Century Ltd completed
a private placement offering (the “Private Placement”)
of 5,434,446 securities (the “PPO Securities”) at the
purchase price of $1.00 per Unit, each such Unit consisting of one
(1) limited liability company membership interest of 22nd Century
Ltd and a five-year warrant to purchase one-half of one (1/2)
limited liability company membership interest of 22nd Century Ltd
at an exercise price of $1.50 per whole common share. In connection
with the Private Placement, 22nd Century Ltd approved a prorata
distribution of 5,000,000 five-year warrants to purchase one
limited liability company membership interest at an exercise price
of $3.00. Private Placement proceeds included $614,070 from
the conversion of 22nd Century Ltd indebtedness into PPO
Securities and $395,376 from the conversion of placement agent
fees into PPO Securities, resulting in gross cash proceeds of
$4,425,000. Private Placement expenses incurred included cash
expenses of approximately $1,025,000 and non-cash expenses
consisting of the placement agent fees of $395,376 which were
converted into PPO Securities and $390,000 for the
estimated fair value of 934,755 placement agent and advisor
warrants issued to the placement agent. An additional $114,979 of
cost was incurred in the second quarter of 2011 in connection with
registration process for the common stock issued in the Private
Placement. 22nd Century Ltd/Group received net cash proceeds of
approximately $3.3 million from the Private Placement and a
reduction of debt and accrued interest obligations to shareholders
that were on the balance sheet at December 31, 2010 of
approximately $614,000, which was exchanged for equity interests in
the offering. A portion of the proceeds were allocated to the
warrants issued, which are classified as liabilities (see Note
9).
Basis of Presentation - The accompanying
unaudited statements have been prepared in accordance with U.S.
generally accepted accounting principles (GAAP) for interim
financial information. Accordingly, they do not include all of the
information and footnotes required by GAAP for complete financial
statements. In the opinion of management, all adjustments,
consisting of normal recurring accruals, considered necessary for a
fair and non-misleading presentation of the financial statements
have been included.
The
results of operations for any interim period are not necessarily
indicative of results for the full year. Operating results for the
six months ended June 30, 2011 are not necessarily indicative of
the results that may be expected for the year ending
December 31, 2011. The balance sheet at December 31, 2010
has been derived from the audited financial statements at that
date, but does not include all of the information and footnotes
required by GAAP for complete financial statements.
Nature of Business - 22nd
Century Group is a holding company and is the sole member of 22nd
Century Ltd, which is a plant biotechnology company. 22nd Century
Ltd owns or exclusively licenses 98 issued patents in 79 countries
predominantly related to modifying the content of nicotinic
alkaloids in plants, specifically tobacco plants, through genetic
engineering and plant breeding.
The
overall objectives of 22nd Century Ltd are to reduce
smoking-related disease by increasing smoking cessation with
X-22, its
botanical prescription smoking cessation aid in development, and
reducing the harm to smokers with 22nd Century’s potential
modified risk tobacco products (as defined in the Overview of
Management Discussion), for smokers unwilling to
quit. 22nd Century Ltd, including its subsidiary,
Goodrich Tobacco Company Ltd. (“Goodrich Tobacco”), is
primarily involved in the following activities:
Principles of Consolidation - The
accompanying consolidated financial statements include the accounts
of 22nd Century Group, 22nd Century Ltd, and Goodrich Tobacco, a
subsidiary of 22nd Century Ltd. 22nd Century Ltd owns 96% of the
outstanding membership units of Goodrich Tobacco. All intercompany
accounts and transactions have been eliminated.
Inventory - Inventories are valued at the lower of cost or
market. Cost is determined on the first-in, first-out
(FIFO) method. The Company’s inventory
consisted of the following categories:
Intangible Assets - Intangible assets are recorded at cost
and consist primarily of expenditures incurred with third parties
related to the processing of patent claims and trademarks with
government authorities. The Company also capitalized costs as a
result of one of its exclusively licensed patent applications being
subject to an interference proceeding invoked by the U.S. Patent
and Trademark Office, which favorably resulted in the Company
obtaining rights to a third party’s issued patent. The
amounts capitalized relate to patents the Company owns or to which
it has exclusive rights and its trademarks, and exclude
approximately $1.8 million recovered from a former licensee as
direct reimbursements of costs incurred. These capitalized costs
are amortized using the straight-line method over the remaining
statutory life of the Company’s primary patent family, which
expires in 2019 (the assets’ estimated lives). Periodic
maintenance or renewal fees, which are generally due on an annual
basis, are expensed as incurred. Annual minimum license
fees are charged to expense in the year the licenses are effective.
Total patent and trademark costs capitalized and accumulated
amortization amounted to $2,017,744 and $585,436 as of June 30,
2011 ($1,965,621 and $497,998 - as of December 31,
2010). The estimated annual amortization expense for the
next five years is approximately $179,000.
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 six month periods ended
June 30, 2011 or 2010.
Deferred Private Placement Costs - During 2010, the Company
incurred costs related to the Private Placement that closed on
January 25, 2011. Such costs were accumulated on the balance sheet
as of December 31, 2010 and were charged against contributed
capital upon closing of the offering. Deferred Private
Placement costs were $0 as of June 30, 2011 ($587,133 –
December 31, 2010).
Income Taxes - Following the
Merger on January 25, 2011, 22nd Century Ltd’s operations are
subject to Federal and State income taxes. Accordingly,
since the Merger date the Company is required to recognize deferred
tax assets and liabilities for any differences in basis in assets
and liabilities between tax and GAAP reporting. The
corresponding asset that resulted has been fully offset by a
valuation allowance based on the uncertainty of the Company’s
ability to generate taxable income in the future to allow for the
utilization of the asset. The Company incurred a net
operating loss from the closing of the Merger to June 30, 2011 and,
accordingly, has made no provision for current income taxes. The
income tax asset arising from this net operating loss has been
fully reserved because it is not probable that it will be
realized
Prior
to the Merger, 22nd Century Ltd had elected to be treated as a
Partnership for federal and state income tax
purposes. As a result, there was no entity level income
tax for periods prior to the Merger, because all taxable income,
tax deductions and tax credits were passed through to the members
of 22nd Century Ltd. 22nd Century Ltd’s federal and state tax
returns for the years ended December 31, 2007 to December 31, 2010
are currently open to audit under statutes of limitations. There
are no pending audits as of June 30, 2011.
Employee Equity-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.
Debt Discounts - The Company accounts for warrants issued to
note holders as an inducement to provide financing for the Company
in accordance with the FASB’s guidance on Accounting for
Convertible Debt and Convertible Debt Issued with Stock Purchase
Warrants. Fair value of the warrants is determined by common share
price according to recent equity transactions, since there is no
vesting period and a negligible exercise price. The proceeds
allocated to each warrant is recorded as a debt discount and
amortized over the life of the corresponding financing as interest
expense.
Unearned Grant Revenue - 22nd
Century Ltd received approval of a government grant as partial
support for its next clinical trial for the FDA. Costs associated
with this grant are being recognized as such costs are incurred and
included in research and development expense. As the
costs are incurred, deferred revenue is also recognized into
income. During the six months ended June 30, 2011, the
Company recognized $143,540, which is included in other income on
the statement of operations. Deferred grant revenue was
$80,000 as of June 30, 2011 (as compared to $223,540 as of December
31, 2010).
Revenue Recognition - The Company recognizes revenue 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 and exported
cigarettes in 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 research cigarettes which includes four development stages.
Stages 1 and 2 are for product design, stage 3 is for manufacture
planning and material procurement and stage 4 is for the
manufacture, laboratory testing for confirmation of specifications,
labeling of the product pursuant to the specifications of the
Alcohol and Tobacco Tax and Trade Bureau (“TTB”) as a
federal-excise tax-free product and shipping of the 9,000,000
cigarettes. Revenue under this contract is recognized as milestones
are met since the milestones are clearly identifiable and
substantive. The Company has completed each of stages 1 to 3 and
recognized the revenue when billing was approved by the
customer. The Company has also completed certain
milestones of stage 4 related to the laboratory testing and product
labeling according to TTB specifications, as defined in the
customer’s purchase order. Revenue related to the manufacture
and shipment of the cigarettes will be based on the number of
cigarettes that are shipped to the customer when title has
transferred. The Company began cigarette shipments under stage 4 in
July 2011. These government research cigarettes are distributed
under the mark SPECTRUM.
Derivatives - 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. 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.
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 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.
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NOTE 1. - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
Nature of Business - 22nd Century
Limited, LLC (“22nd Century”) is a plant biotechnology
company founded in 1998. 22nd Century owns or has the
exclusive right to use more than 97 issued patents in more than 79
countries related to modifying the content of nicotinic alkaloids
in plants, specifically tobacco plants, through genetic engineering
and plant breeding.
The
overall objective of 22nd Century is to reduce smoking-related
disease by increasing smoking cessation with, X-22, its botanical
smoking cessation aid and reducing the harm to smokers with 22nd
Century’s potential modified risk cigarettes, for smokers
unwilling to quit.
22nd
Century is primarily involved in the following
activities:
Principles of Consolidation - The
accompanying consolidated financial statements include Goodrich
Tobacco Company LLC (f/k/a Xodus, LLC), a subsidiary of 22nd
Century (collectively, the “Company”). 22nd Century
owns 96% of the outstanding Membership Units of Goodrich Tobacco
Company. All intercompany accounts and transactions have been
eliminated.
Inventory - Inventories are valued at the lower of cost or
market. Cost is determined on the first-in, first-out
(FIFO) method. The Company’s inventory consisted
of the following categories:
Intangible Assets - Intangible assets are recorded at cost
and consist primarily of expenditures incurred with third parties
related to the processing of patent claims and trademarks with
government authorities. The Company also capitalized costs as a
result of one of its exclusively licensed patent application being
subject to an interference proceeding invoked by the U.S. Patent
and Trademark Office, which favorably resulted in the Company
obtaining rights to a third party’s issued patent. The
amounts capitalized relate to patents the Company owns or has
exclusive rights to and its trademarks, and exclude approximately
$1.8 million recovered from a former licensee as direct
reimbursements of costs incurred. These capitalized costs are
amortized using the straight-line method over the remaining
statutory life of the Company’s primary patent family, which
expires in 2019 (the assets’ estimated lives). Periodic
maintenance or renewal fees, which are generally due on an annual
basis are expensed as incurred. Annual minimum license fees
are charged to expense in the year the licenses are effective.
Total patent and trademark costs capitalized and accumulated
amortization amounted to $1,965,621 and $497,998 as of December 31,
2010 ($1,817,709 and $333,542 - 2009). Expected future annual
amortization of patent costs and trademarks is approximately
$173,000.
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,
2010 or 2009.
Deferred Private Placement Costs - During 2010 the Company
incurred costs related to the private placement that closed on
January 25, 2011. Such costs were accumulated on the balance sheet
and were charged against contributed capital upon closing of the
offering. Deferred private placement costs amounted to
$587,133 as of December 31, 2010 ($0 – 2009).
Income Taxes - The Company
has elected to be treated as a Partnership for Federal and State
income tax purposes. As a result, there is no corporate level
tax because all taxable income, tax deductions and tax credits are
passed through to the members of the Company. The Company’s
Federal and State tax returns for the years ended December 31, 2007
to December 31, 2010 are currently open to audit under statutes of
limitations.
Following
the merger on January 25, 2011 (see Note 12) the Company’s
operations will be subject to Federal and State income
taxes.
Employee Equity-Based Compensation - The Company
uses a fair-value based method to determine compensation for all
arrangements under which Company members, employees and others
receive Membership Units or warrants to purchase Membership Units
of the Company.
Debt Discounts - The Company accounts for warrants issued to
note holders as an inducement to provide financing for the Company
in accordance with the FASB’s guidance on Accounting for
Convertible Debt and Convertible Debt Issued with Stock Purchase
Warrants. Fair value of the warrants is determined by Membership
Unit price according to recent equity transactions since there is
no vesting period and a negligible exercise price. The proceeds
allocated to the warrant is recorded as a debt discount and
amortized over the life of the corresponding financing as interest
expense.
Unearned Grant Income - The
Company received approval of a government grant as partial support
for its next clinical trial with the FDA. This grant will be
recognized as a reduction of the cost of the clinical trial as such
costs are incurred. As of December 31, 2010, the Company recorded a
grant receivable and corresponding deferred grant revenue amounting
to $223,540. No unearned grant income existed as of December
31, 2009.
Revenue Recognition - The Company recognizes revenue 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. Federal Excise Taxes are included in net sales and
accounts receivable billed to customers.
Shipping Costs - Shipping costs
are included in general and administrative expense and aggregated
$2,290 in 2010 ($2,262 – 2009).
Advertising Costs - Advertising costs
are expensed as incurred and are included in general and
administrative expense. Advertising costs for the year ended
December 31, 2010 amounted to $3,520 ($979 –
2009).
Research and Development - Research and
development costs are expensed as incurred.
Loss Per Common Unit - Basic loss per
common Membership Unit is computed using the weighted-average
number of common Membership Units outstanding. Diluted loss
per unit is computed assuming conversion of all potentially
dilutive warrants. Potential common Membership Units 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 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.
Reclassifications - Certain 2009 amounts have been
reclassified to conform to the 2010 presentation.
Membership Units Split - On October 5, 2010 the Company
authorized a 37,100.5626 to 1 split of its Membership Units. The
amounts shown for Membership Units, warrants and loss per unit
amounts have been retroactively adjusted in all periods presented
to reflect this split.
Subsequent Events - These statements have not been updated
for subsequent events occurring after March 21, 2011, which is the
date these financial statements were available to be
issued.
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