Attached files
EXHIBIT 99.1
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of
Directors and Stockholders
22nd
Century Limited, LLC and Subsidiary
We have
audited the accompanying consolidated balance sheets of 22nd Century Limited,
LLC and Subsidiary as of December 31, 2009 and 2008, and the related
consolidated statements of operations, members’ deficit, 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. The
Company is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audits included
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the Company’s
internal control over financial reporting. Accordingly, we express no
such opinion. 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.
As
discussed in the restatement paragraph within Note 1 to the consolidated
financial statements, 22nd Century Limited, LLC and Subsidiary has updated its
previously issued 2009 financial statements to retroactively reflect a subsequent
37,100.5626 to 1 split of its Membership Units that was authorized by the
Company on October 5, 2010.
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of 22nd Century Limited, LLC as
of December 31, 2009 and 2008, and the consolidated results of its operations
and its cash flows for the years then ended in conformity with accounting
principles generally accepted in the United States of America.
The accompanying consolidated financial
statements have been prepared assuming that the Company will continue as a going
concern. As discussed in Note 2 to the consolidated financial
statements, since 2006 the Company has suffered recurring losses from operations
and has negative working capital of approximately $3.2 million as of December
31, 2009. This raises substantial doubt about the Company's ability
to continue as a going concern. Management's plans in regard to these
matters are also described in Note 2. The consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
/s/ Freed
Maxick & Battaglia, CPAs, PC
Buffalo,
New York
June 1,
2010, except for items disclosed in Note 1 regarding
restatement
and Note 12, as to which the date is October 15, 2010.
- 1
-
22ND
CENTURY LIMITED, LLC AND SUBSIDIARY
|
CONSOLIDATED
BALANCE SHEETS
|
DECEMBER
31,
|
2009
|
2008
|
|||||||
ASSETS
|
||||||||
Current
assets:
|
||||||||
Cash
|
$ | 158 | $ | 13,561 | ||||
Inventory
|
55,023 | 25,000 | ||||||
Total
current assets
|
55,181 | 38,561 | ||||||
Other
assets:
|
||||||||
Patent
and trademark costs, net
|
1,484,167 | 1,401,117 | ||||||
Debt
issuance costs, net
|
35,923 | 79,031 | ||||||
Deposits
|
1,535 | 1,535 | ||||||
Total
other assets
|
1,521,625 | 1,481,683 | ||||||
Total
assets
|
$ | 1,576,806 | $ | 1,520,244 | ||||
LIABILITIES
AND MEMBERS' DEFICIT
|
||||||||
Current
liabilities:
|
||||||||
Demand
bank loans
|
$ | 246,735 | $ | 248,106 | ||||
Accounts
payable
|
2,138,207 | 1,697,077 | ||||||
Accrued
expenses
|
116,688 | 23,329 | ||||||
Notes
payable, net of unamortized discount
|
308,891 | 6,000 | ||||||
Notes
payable to members, net of unamortized
|
||||||||
discounts
|
306,060 | — | ||||||
Due
to related party
|
126,970 | 57,809 | ||||||
Due
to members
|
930 | 277,650 | ||||||
Total
current liabilities
|
3,244,481 | 2,309,971 | ||||||
Long-term
convertible, subordinated
|
||||||||
notes
to members
|
100,014 | 177,749 | ||||||
Long-term
subordinated note to member
|
30,054 | — | ||||||
Note
payable, net of unamortized discount
|
— | 206,291 | ||||||
Note
payable to member, net of unamortized
|
||||||||
discounts
|
— | 206,291 | ||||||
Total
liabilities
|
3,374,549 | 2,900,302 | ||||||
Commitments
and contingencies (Note 9)
|
— | — | ||||||
Members'
deficit:
|
||||||||
Contributed
capital
|
2,466,138 | 1,657,019 | ||||||
Accumulated
deficit
|
(4,263,762 | ) | (3,037,077 | ) | ||||
Non-controlling
interest - consolidated subsidiary
|
(119 | ) | — | |||||
Total
members' deficit
|
(1,797,743 | ) | (1,380,058 | ) | ||||
Total
liabilities and members' deficit
|
$ | 1,576,806 | $ | 1,520,244 | ||||
See accompanying notes to consolidated financial
statements.
- 2
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22ND
CENTURY LIMITED, LLC AND SUBSIDIARY
|
CONSOLIDATED
STATEMENTS OF OPERATIONS
|
For
the Years Ended December 31,
|
2009
|
2008
|
|||||||
Revenues:
|
||||||||
Product
sales
|
$ | 27,612 | $ | — | ||||
Royalty
income
|
— | 201,635 | ||||||
27,612 | 201,635 | |||||||
Cost
of sales
|
20,112 | — | ||||||
Gross
profit
|
7,500 | 201,635 | ||||||
Operating
expenses:
|
||||||||
Research
and development
|
540,300 | 654,497 | ||||||
Selling,
general and administrative
|
280,709 | 147,870 | ||||||
Amortization
|
144,792 | 99,970 | ||||||
965,801 | 902,337 | |||||||
Operating
loss
|
(958,301 | ) | (700,702 | ) | ||||
Other
income (expense):
|
||||||||
Interest
and debt expense
|
(268,503 | ) | (70,563 | ) | ||||
Interest
income
|
— | 34,886 | ||||||
(268,503 | ) | (35,677 | ) | |||||
Net
loss
|
(1,226,804 | ) | (736,379 | ) | ||||
Net
loss attributable to non-controlling interest
|
119 | — | ||||||
Net
loss attributed to members
|
$ | (1,226,685 | ) | $ | (736,379 | ) | ||
Loss
per common unit - basic and diluted
|
$ | (0.23 | ) | $ | (0.14 | ) | ||
Shares
used in basic earnings per unit calculation
|
5,304,423 | 5,238,176 | ||||||
See accompanying notes to consolidated financial
statements.
- 3
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22ND
CENTURY LIMITED, LLC AND SUBSIDIARY
|
CONSOLIDATED
STATEMENTS OF MEMBERS' DEFICIT
|
For
the Years Ended December 31,
|
Member
Units
|
||||||||||||||||||||
Outstanding
|
Contributed
|
Accumulated
|
Non-controlling
|
Members'
|
||||||||||||||||
(restated)
|
Capital
|
Deficit
|
Interest
|
Deficit
|
||||||||||||||||
Balance
at December 31, 2007
|
5,238,176 | $ | 1,290,649 | $ | (2,300,698 | ) | $ | — | $ | (1,010,049 | ) | |||||||||
Warrants
issued in exchange for services
|
— | 21,154 | — | — | 21,154 | |||||||||||||||
Warrants
issued with debt
|
— | 259,000 | — | — | 259,000 | |||||||||||||||
Warrants
issued to guarantor of debt
|
— | 86,216 | — | — | 86,216 | |||||||||||||||
Net
loss
|
— | — | (736,379 | ) | — | (736,379 | ) | |||||||||||||
Balance
at December 31, 2008
|
5,238,176 | $ | 1,657,019 | $ | (3,037,077 | ) | $ | — | $ | (1,380,058 | ) | |||||||||
Member
Units issued in exchange for services
|
74,201 | 18,333 | — | — | 18,333 | |||||||||||||||
Warrants
issued in exchange for services
|
— | 21,859 | — | — | 21,859 | |||||||||||||||
Member
Units issued as compensation in lieu of cash
|
630,710 | 155,833 | — | — | 155,833 | |||||||||||||||
Xodus,
LLC units issued as compensation in lieu of cash
|
— | 36,000 | — | — | 36,000 | |||||||||||||||
Expensed
portion of warrants issued as compensation
|
— | 215,554 | — | — | 215,554 | |||||||||||||||
Conversion
of member advances to Membership Units
|
1,009,106 | 271,992 | — | — | 271,992 | |||||||||||||||
Conversion
of member note and accrued interest
|
||||||||||||||||||||
to
Membership Units
|
151,760 | 88,172 | — | — | 88,172 | |||||||||||||||
Warrants
issued with debt
|
— | 36,395 | — | — | 36,395 | |||||||||||||||
Redemption
of Membership Units
|
(51,637 | ) | (35,019 | ) | — | — | (35,019 | ) | ||||||||||||
Warrants
exercised for Membership Units
|
37,624 | — | — | — | — | |||||||||||||||
Net
loss
|
— | — | (1,226,685 | ) | (119 | ) | (1,226,804 | ) | ||||||||||||
Balance
at December 31, 2009
|
7,089,940 | $ | 2,466,138 | $ | (4,263,762 | ) | $ | (119 | ) | $ | (1,797,743 | ) | ||||||||
See accompanying notes to consolidated financial
statements.
- 4
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22ND
CENTURY LIMITED, LLC AND SUBSIDIARY
|
CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
For
the Years Ended December 31,
|
2009
|
2008
|
|||||||
Cash
flows from operating activities:
|
||||||||
Net
loss
|
$ | (1,226,804 | ) | $ | (736,379 | ) | ||
Adjustments
to reconcile net loss to cash used
|
||||||||
by
operating activities:
|
||||||||
Amortization
of intangible assets
|
144,792 | 99,970 | ||||||
Amortization
of debt issuance costs
|
43,108 | 7,185 | ||||||
Amortization
of warrants issued with notes payable
|
142,745 | 21,583 | ||||||
Equity
based employee compensation expense
|
407,387 | — | ||||||
Equity
based payments for outside services
|
40,192 | 21,154 | ||||||
Services
recorded to member advances
|
— | 52,880 | ||||||
Write-off
of other asset
|
— | 8,000 | ||||||
Increase
in assets:
|
||||||||
Inventory
|
(30,023 | ) | — | |||||
Increase
(decrease) in liabilities:
|
||||||||
Accounts
payable
|
220,031 | 42,848 | ||||||
Accrued
expenses
|
93,359 | (11,117 | ) | |||||
Net
cash used by operating activities
|
(165,213 | ) | (493,876 | ) | ||||
Cash
flows from investing activities:
|
||||||||
Acquisition
of patents and trademarks
|
(6,840 | ) | (268,322 | ) | ||||
Net
cash used by investing activities
|
(6,840 | ) | (268,322 | ) | ||||
Cash
flows from financing activities:
|
||||||||
Repayment
of bank loans
|
(1,371 | ) | (21,622 | ) | ||||
Proceeds
from issuance of notes and related warrants
|
55,000 | 331,000 | ||||||
Proceeds
from issuance of notes and
|
||||||||
related
warrants to member
|
— | 325,000 | ||||||
Proceeds
from issuance of convertible, subordinated
|
||||||||
notes
to members
|
— | 6,300 | ||||||
Net
advances (repayments) from related party
|
69,161 | (89,847 | ) | |||||
Net
advances from members
|
35,860 | 224,770 | ||||||
Net
cash used by financing activities
|
158,650 | 775,601 | ||||||
Net
(decrease) increase in cash
|
(13,403 | ) | 13,403 | |||||
Cash
- beginning of year
|
13,561 | 158 | ||||||
Cash
- end of year
|
$ | 158 | $ | 13,561 | ||||
Cash
paid during the year for:
|
||||||||
Interest
|
$ | 5,661 | $ | 17,435 | ||||
Supplemental
disclosure of noncash investing
|
||||||||
and
financing activities:
|
||||||||
Patent
and trademark additions included in
|
||||||||
accounts
payable
|
$ | 221,102 | $ | 469,196 | ||||
Conversion
of member advances to Membership Units
|
$ | 271,992 | $ | — | ||||
Conversion
of member note and accrued interest
|
||||||||
to
Membership Units
|
$ | 88,172 | $ | — | ||||
Note
payable issued to repurchase Membership Units
|
$ | 35,019 | $ | — | ||||
Debt
discount related to warrants issued with
|
||||||||
notes
payable
|
$ | 36,395 | $ | 259,000 | ||||
Debt
issuance costs associated with warrants issued
|
||||||||
to
guarantor
|
$ | — | $ | 86,216 | ||||
See accompanying notes to consolidated financial
statements.
- 5
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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 exclusively controls 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 its botanical smoking cessation aid, X-22 and reducing the harm to
smokers with 22nd Century’s potential modified risk cigarettes, Brand A and Brand B for smokers unwilling
to quit. 22nd Century does not currently and does not intend to market
conventional cigarettes.
22nd
Century is primarily involved in the following activities:
|
·
|
The
development of its botanical smoking cessation aid, X-22;
|
|
·
|
The
development of its modified risk tobacco products, Brand A and Brand
B;
|
|
·
|
The
pursuit of necessary regulatory approvals at the FDA to market X-22 as a prescription
smoking cessation aid and Brand A and Brand
B as
modified risk tobacco products in the
U.S.;
|
|
·
|
The
manufacture, marketing and distribution of cigarettes in the traditional
tobacco products market in the U.S. through its subsidiary Xodus LLC;
and
|
|
·
|
The
international licensing of 22nd Century’s trademarks, brands, proprietary
tobaccos, and technology.
|
Principles of
Consolidation - The accompanying
consolidated financial statements include Xodus, LLC, a subsidiary of 22nd
Century (collectively, the “Company”). 22nd Century owns 96% of the outstanding
Membership Units of Xodus, LLC. All intercompany accounts and transactions have
been eliminated.
Inventory
- The Company’s inventory was made up entirely of crop leaf (raw materials) as
of December 31, 2009 and 2008. Inventories are valued at the lower of
cost or market. Cost is determined on the first-in, first-out
(FIFO) method.
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 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 $1,817,709 and $333,542 as
of December 31, 2009 ($1,589,767 and $188,650 - 2008).
- 6
-
NOTE
1. - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
Expected
future amortization of patent costs and trademarks is as follows:
Years
ending December 31,
|
||||
2010
|
$ | 156,238 | ||
2011
|
156,238 | |||
2012
|
156,238 | |||
2013
|
156,238 | |||
2014
|
156,238 | |||
Thereafter
|
702,977 | |||
$ | 1,484,167 |
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, 2009 or
2008.
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.
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 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 unit price according to
recent equity transactions since there is no vesting period and a negligible
exercise price. The proceeds allocated to the warrant based on the fair value is
recorded as a debt discount and amortized over the life of the corresponding
financing as interest expense.
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
account receivable billed to customers.
Shipping
Costs -
Shipping costs are included in selling, general and administrative expense and
aggregated $2,262 in 2009 ($0 – 2008).
- 7
-
NOTE
1. - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
Advertising Costs
- Advertising
costs are expensed as incurred and are included in selling, general and
administrative expense. Advertising costs for the year ended December 31,
2009 amounted to $979 ($1,912 – 2008).
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.
Restatement
- Subsequent to the original issuance of the financial statements, the
Company authorized a 37,100.5626 to 1 split of its Membership Units on October
5, 2010. These financial statements have been restated to present the revised
number of units and loss per unit as a result of the split.
There
were no changes to the balance sheets, statements of operations and statements
of cash flows as a result of this restatement.
Recent Accounting
and Reporting Pronouncements - In June 2009,
the FASB issued Statement No. 168, The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting
Principles—a replacement of FASB Statement No. 162 (FAS 168). The
Codification became the source of authoritative GAAP recognized by the FASB to
be applied by nongovernmental entities. Rules and interpretive releases of the
SEC under authority of federal securities laws are also sources of authoritative
GAAP for SEC registrants. On the effective date of FAS 168, the Codification
superseded all then-existing non-SEC accounting and reporting standards. All
other non-grandfathered non-SEC accounting literature not included in the
Codification became non-authoritative. FAS 168 was effective for financial
statements issued for interim and annual periods ending after September 15,
2009. The adoption of FAS 168 did not affect the Company’s consolidated
financial position, results of operations, or cash flows.
- 8
-
NOTE
1. - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES(CONTINUED)
Effective
June 1, 2009, the Company adopted new guidance on subsequent events. The
objective of this guidance is to establish general standards of accounting for
and disclosures of events that occur after the consolidated balance sheet date
but before the consolidated financial statements are issued or are available to
be issued. The Company has evaluated and disclosed any material subsequent
events through June 1, 2010. This adoption did not have any impact on the
Company’s results of operations or financial condition.
In
December 2007, the FASB issued SFAS 160, Non-controlling Interests in
Consolidated Financial Statements, an amendment of ARB 51 (subsequently
incorporated into the FASB Accounting Standards Codification). This Statement
amends US GAAP to establish accounting and reporting standards for the
non-controlling interest in a subsidiary and for the deconsolidation of a
subsidiary. It also clarifies that a non-controlling interest in a subsidiary is
an ownership interest in the consolidated entity that should be reported as
equity in the consolidated financial statements. It requires consolidated net
income or loss to be reported at amounts that include the amounts attributable
to both the parent and the non-controlling interest. Additionally, this
Statement establishes a single method of accounting for changes in a parent’s
ownership interest in a subsidiary that does not result in a change in control.
This Statement is effective for the first annual reporting period beginning on
or after December 31, 2008. The Company adopted the FASB’s guidance
on Non-controlling Interests
in Consolidated Financial Statements on January 1, 2009 and discloses the
balance of the non-controlling interest in 22nd Century’s subsidiary on the
Company’s balance sheet.
NOTE
2. - LIQUIDITY AND MANAGEMENT’S PLANS
Since
2006, 22nd Century has experienced limited revenues and incurred substantial
operating losses as it transitioned from being only a licensor of its
proprietary technology and tobaccos to commercializing its own tobacco products.
At December 31, 2009, the Company had current assets of $55,181 and current
liabilities of $3,244,481. The Company, raised $765,000 in equity financing plus
an additional $45,000 in debt financing during the five months ended May 31,
2010 in order to continue its operations. The Company needs to raise additional
capital to reduce outstanding current liabilities and complete the FDA-approval
process for X-22. The
Company’s ability to reduce outstanding current liabilities, undertake and
complete the necessary clinical trials and related activities for FDA-approval
of X-22 will be
dependent upon additional funding. On February 24, 2010 the Company engaged
Rodman & Renshaw, LLC to serve as exclusive placement agent, on a best
efforts basis, to raise equity capital in the Company. The ability to complete
this equity placement and other future financings on acceptable terms will
depend on a number of factors, including the general performance of the capital
markets, the Company’s progress in the FDA approval process and the manufacture,
distribution and sale of its products. Any equity financing will be dilutive to
the Company’s existing shareholders ownership percentages.
National
distribution in the U.S. of cigarettes is planned to occur in the first quarter
of 2011. The Company also expects to start exporting Brand A and/or Brand A
tobacco in 2011. The Company further expects to start
exporting Brand B and/or Brand B tobacco in 2011. Thus, the
Company expects sales
to rapidly grow in 2011.
The
Company’s believes, but can offer no assurances that the above business plans
will provide sufficient cash flow to fund the Company’s operations during
2010.
- 9
-
NOTE
3. - AMOUNTS OWED NORTH CAROLINA STATE UNIVERSITY (“NCSU”)
Pursuant
to the terms of an exclusive license agreement with NCSU, the Company owes NCSU
approximately $1,045,000 as of December 31, 2009 for patent costs ($887,000 –
2008), including the costs associated with the interference invoked by the U.S.
Patent and Trademark Office. These amounts are included in accounts payable in
the consolidated balance sheets. The Company is required to pay these amounts
within thirty days of being invoiced and they are past due. NCSU has
the right to send a 60-day written notice to Company to demand payment and claim
interest on the balance and if the total amount is not paid within 60 days, NCSU
may elect to terminate the license agreement. The Company has made payments on
account from time to time and plans substantial or complete payment to NCSU. In
a letter agreement dated March 31, 2010 between NCSU and the Company, which was
requested by the Company to facilitate its equity capital raise discussed in
Note 2, NSCU has agreed it would not exercise any rights it may have to
terminate the agreement through December 1, 2010 for non-payment of such patent
costs. Subsequent to the agreement not to terminate, NCSU may have
the right to cancel the exclusive license agreement. As of December
31, 2009, patent costs associated with the exclusive license agreements that
could potentially be terminated had a carrying value of approximately $792,000.
Additionally, NCSU has 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 as of and for the years ended December 31, 2009 and 2008. The
Company intends to pay a substantial portion of the outstanding payable in the
event it is successful in its equity capital raise discussed in Note
2.
NOTE 4. - DEMAND BANK
LOANS
The
demand loans are payable to two commercial banks under revolving credit
agreements. In both cases the loans are guaranteed by a member of the
Company.
The first
demand loan, has a balance of $174,925 at both December 31, 2009 and 2008. The
Company is required to pay interest monthly at 0.75% above the prime rate, 4.00%
all-in at December 31, 2009 (4.00% - 2008). The Company has met this interest
payment obligation of the first demand loan. The terms of the demand loan
includes an annual “clean-up” provision, which require the Company to repay all
principal amounts outstanding. The Company has not complied with this
requirement, however, the bank has not demanded payment.
The
second demand loan has a balance of $71,810 at December 31, 2009 ($73,181 –
2008). The Company is required to pay interest monthly at 1.00% above the prime
rate, 4.25% all-in at December 31, 2009 (4.25% - 2008). This demand
loan requires monthly principal reductions of 2% of the balance outstanding and
includes an annual “clean-up” provision, which requires the Company to repay 50%
of the principal amounts outstanding. The Company has not complied with these
requirements. The bank has demanded payment and the bank and the Company have
reached a Forbearance Agreement dated June 13, 2009, which stipulates monthly
payments of $1,560 including interest at the rate of 5% per annum. The Company
has not complied with all of the terms of the Forbearance Agreement, however,
the bank has since taken action to seek payment from an officer/member who is a
guarantor of the loan. The company paid $56,000 in October 2010
towards amounts due and the bank has agreed to allow the Company to pay the
$16,000 balance in November 2010.
- 10
-
NOTE
5. - NOTES PAYABLE
Notes payable, net of unamortized
discount -
2009
|
2008
|
|||||||
Note
dated October 28, 2008, net of unamortized discount
|
$ | 271,041 | $ | 206,291 | ||||
Note
dated May 20, 2009, net of unamortized discount
|
20,367 | — | ||||||
Note
dated September 15, 2009, net of amortized discount
|
6,995 | — | ||||||
Note
dated October 15, 2009, net of amortized discount
|
4,488 | — | ||||||
Other
note payable
|
6,000 | 6,000 | ||||||
308,891 | 212,291 | |||||||
Current
notes payable, net
|
308,891 | 6,000 | ||||||
Long-term
notes payable, net
|
$ | — | $ | 206,291 |
Note dated
October 28, 2008 - On October 28, 2008, the Company issued a note payable
to a third party in the amount of $325,000, and a warrant to purchase
371,006 Membership Units at less than $.0001 per unit. The
warrant was valued at $129,500 and recorded as a discount to the note payable
and is being amortized over the term of the note which significantly adjusts the
effective interest rate. The weighted average annual effective rate on the note
is 41%. The intrinsic value of the warrant at the time of issuance was
determined to be $215,540; the debt discount recorded was based on allocating
the $325,000 in transaction proceeds proportionally between the note and the
warrant. The note bears interest at a rate of 10% and the outstanding
principal and interest is due and payable on October 28, 2010, the maturity
date. As of December 31, 2009, the outstanding principal and
unamortized debt discount amounted to $325,000 and $53,959, ($325,000 and
$118,709 – 2008), respectively. The note is guaranteed by a related
party, Virgil Properties, LLC (Virgil), which is owned by two members of the
Company. The note is secured by a mortgage on property owned by
Virgil. Virgil received 148,402 warrants as consideration for this guarantee.
These warrants were valued at $86,216 and recorded as a deferred financing cost
being amortized over the term of the loan. On December 30, 2009, Virgil agreed
to rescind these warrants. In consideration of the rescission of warrants, the
Company agreed to convert certain cash advances totaling $271,992 from the two
members of the Company that own Vigil into 1,009,106 Membership Units of the
Company.
Note dated May
20, 2009 (unsecured)
- On May 20, 2009, the Company issued a note payable to a third party in the
amount of $30,000, and a warrant to purchase 185,503 Membership Units at
less than $.0001 per unit. The warrant was valued at $18,132 and
recorded as a discount to the note payable and is being amortized over the term
of the note, which significantly adjusts the effective interest rate. The
weighted average annual effective rate on the note is 178%. The intrinsic value
of the warrants at the time of issuance was determined to be $45,833; the debt
discount recorded was based on allocating the $30,000 in transaction proceeds
proportionally between the notes and the warrant. The note bears
interest at a rate of 10% and the outstanding principal and interest is due and
payable on May 19, 2010, the maturity date. As of December 31, 2009,
the outstanding principal and unamortized debt discount amounted to $30,000 and
$9,633, respectively.
- 11
-
NOTE
5. - NOTES PAYABLE (CONTINUED)
Notes dated
September 15 and October 15, 2009 (unsecured)
- On September 15 and October 15, 2009, the Company issued two notes payable to
the same third party in the amounts of $15,000 and $10,000,
respectively. In conjunction with the $15,000 note, a warrant to
purchase 185,503 Membership Units at less than $.0001 per unit was issued,
and in conjunction with the $10,000 note, a warrant to purchase
92,751 Membership Units at less than $.0001 per unit was
issued. The warrants were valued at $11,301 for the $15,000 note and
$6,962 for the $10,000 and recorded as discounts to the respective notes payable
and are being amortized over the term of each note which significantly adjusts
the effective interest rate. The weighted average annual effective rate on these
notes is 308%. The intrinsic value of the warrants at the time of issuance was
determined to be $68,750; the debt discount recorded was based on allocating the
$25,000 in transaction proceeds proportionally between the notes and the
warrants. The notes bear interest at a rate of 10% and the outstanding principal
and interest is due and payable on September 15, 2010 for the $15,000 note and
October 15, 2010 for the $10,000 note. As of December 31, 2009, the
total outstanding principal and unamortized debt discounts for the two notes
amounted to $25,000 and $13,517, respectively. As of May 27, 2010, the maturity
dates of these notes were extended to January 31, 2012.
Notes payable to members, net of
unamortized discount -
2009
|
2008
|
|||||||
Note
dated November 11, 2008, net of unamortized discount
|
$ | 271,041 | $ | 206,291 | ||||
Note
payable to repurchase Membership Units
|
35,019 | — | ||||||
306,060 | 206,291 | |||||||
Current
notes payable, net
|
306,060 | — | ||||||
Long-term
notes payable, net
|
$ | — | $ | 206,291 |
Note dated
November 11, 2008 - On November 11, 2008, the Company issued a note
payable to a member in the amount of $325,000, and a warrant to purchase
370,106 Membership Units at less than $.0001 per unit. The
warrant valued at $129,500 and was recorded as a discount to the note payable
and is being amortized over the term of the note which significantly adjusts the
effective interest rate. The weighted average annual effective rate on the note
is 41%. The intrinsic value of the warrant at the time of issuance was
determined to be $215,540; the debt discount recorded was based on allocating
the $325,000 in transaction proceeds proportionally between the note and the
warrant. The note bears interest at a rate of 10% and the
outstanding principal and interest is due and payable on November 11, 2010, the
maturity date. As of December 31, 2009, the outstanding principal and
unamortized debt discount amounted to $325,000 and $53,959, ($325,000 and
$118,709 – 2008), respectively. The note is guaranteed by a related
party, Virgil Properties, LLC, which is owned by two members of the
Company. Interest charged on member note for the year ended December
31, 2009 amounted to $32,500 ($4,452 – 2008).
Note payable to
repurchase Membership
Units (unsecured)
- Prior to December 31, 2009, the Company agreed to repurchase
51,637 Membership Units previously issued to the member for $35,019 which
remained unpaid as of December 31, 2009. Subsequently the company issued a note
dated January 1, 2010 to evidence the obligation. The note bears interest at a
rate of 7% and the outstanding principal and interest is due and payable on
September 30, 2010, the maturity date. As of December 31, 2009, the
outstanding principal amounted to $35,019.
- 12
-
NOTE
5. - NOTES PAYABLE (CONTINUED)
Long-term
convertible, subordinated notes to members (unsecured) - The Company issued two
notes to separate members as of January 1, 2008 for $100,315 and
$77,435. Both notes bear interest at a rate of 7%, and interest and
principal are due on the maturity date of January 15, 2011. The time
notes are subordinated to senior debt, which consists of amounts payable on
demand loans to commercial banks, and are convertible into Membership Units at a
rate of $.58 per unit. During 2009, one member converted the entire
principal balance and accrued interest on the note totaling $88,172 into 151,760
units. As of December 31, 2009, the outstanding principal balance on
the remaining note amounted to $100,014. As of December 31, 2008,
both notes were outstanding and amounted to $177,749. Interest charged on
members notes for the year ended December 31, 2009 amounted to $12,429 ($12,443
– 2008).
Long-term
subordinated note to member (unsecured) - On December 30, 2009, the
Company issued a subordinated note to a member in exchange for advances the
member previously made to the Company. The original amount of the
note was $30,054 and was outstanding as of December 31, 2009. The
note bears interest at a rate of 10% and has a maturity date of June 30,
2011. The note is subordinated to senior debt, which consists of
amounts payable on demand loans to commercial banks
NOTE
6. - DUE TO RELATED PARTY
The Company has conducted numerous
transactions with a related party, Alternative Cigarettes, Inc.
(“AC”). AC is entirely owned by certain members of the
Company. AC shares office space and employee services with the
Company for which the Company was reimbursed by AC in the amount of $32,387
during 2009 ($57,667 – 2008). The net amount due to AC as a result of advances,
repayments and expenses incurred and reimbursed amounted to $126,970 as of
December 31, 2009 ($57,809 - 2008). No interest has been accrued or paid on
amount due to AC and there are no repayment terms.
NOTE
7. - DUE TO MEMBERS
Amount
due to members is a result of member advances to the Company for working capital
purposes or services recorded as member advances. During 2008,
$344,487 of member advances were converted to a member time note and a note
payable as discussed in Note 6. During 2009, two members accepted
504,553 Membership Units each in exchange for $135,996 of advances owed to each
member by the Company. Also, during 2009, one member converted
$30,054 of amounts due into a subordinated note payable as discussed in Note
5. As of December 31, 2009, the remaining unpaid amount due to
members for advances to the Company for working capital purposes was $930
($277,650 - 2008). No interest has been accrued or paid on amount due
to members and there are no repayment terms.
- 13
-
NOTE
8. - WARRANTS FOR MEMBERSHIP UNITS
The
Company has granted warrants in connection with borrowings as an additional
incentive for providing financing to the Company and as additional compensation
to officers, consultants and advisors. The warrants are granted with a
conversion price of less than $.0001, and the number of warrants issued has been
negotiated based on the agreement at the time of the grant. The warrants have
been issued for terms of two to five years.
Warrants
issued and outstanding during the years ended December 31, 2009 and 2008
are as follows:
Number
of
|
||||
Warrants
|
||||
Warrants
outstanding at December 31, 2007
|
— | |||
Warrants
issued during 2008
|
927,514 | |||
Warrants
outstanding at December 31, 2008
|
927,514 | |||
Warrants
issued during 2009
|
946,064 | |||
Warrants
exercised during 2009
|
(37,100 | ) | ||
Warrants
forfeited during 2009
|
(148,402 | ) | ||
Warrants
outstanding at December 31, 2009
|
1,688,076 | |||
Warrants
exercisable at December 31, 2009
|
1,242,869 |
The
Company granted an award for service to an executive officer of 445,207
warrants, vesting over a one year service period ending February 1, 2010.
The related compensation cost of $258,648 was determined by the intrinsic value
of the underlying common Membership Units at the time of the award of $0.58 per
unit and is being charged to expense on a straight line basis over the service
period. For the year ended December 31, 2009, $215,558 was recorded as expense
and the unrecognized compensation expense related to non-vested warrants
amounted to $43,090 as of December 31, 2009.
NOTE
9. - COMMITMENTS
License
Agreements - Under its license agreement with NCSU the Company is
required to pay minimum annual royalty payments. The annual minimum royalty for
each of the calendar years 2010 through 2013 is $75,000, in 2014 the annual
minimum increases to $200,000. These minimum royalty payments are due each
February following the end of the applicable calendar year reduced by any
running royalties paid or payable for that year. The agreement also requires a
milestone payment of $150,000 upon FDA approval of a product that uses the
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 2009, the costs incurred related to patent costs amounted to
$169,512 ($452,083 – 2008) and were capitalized and are being amortized over the
remaining patent lives.
The
Company has two other technology license agreements which require aggregate
annual license fees of approximately $50,000.
- 14
-
NOTE
9. - COMMITMENTS (CONTINUED)
Operating Leases
- The Company leases office space under non-cancelable operating leases
for $1,551 per month; expiring in October 2010. Rent expense under the operating
lease was approximately $18,600 for the year ended December 31, 2009
($18,400 – 2008). Future minimum payments due under the operating lease are
approximately $15,700 in 2010.
NOTE
10. - FAIR VALUE OF FINANCIAL INSTRUMENTS
The
estimated fair value of cash, advances from members and related party, demand
bank loans and notes payable approximate the carrying value due to their
short-term nature. In applying the accounting standards for fair value
determination the Company has taken into account what the Company would have to
pay someone to take over its debt obligations. Considerable judgment is required
in developing estimates of fair value. Therefore, the estimates presented herein
are not necessarily indicative of the amounts that the Company would realize in
a current market exchange.
The
estimated fair value of long-term debt is summarized as follows:
2009
|
2008
|
|||||||||||||
Carrying
|
Estimated
|
Carrying
|
Estimated
|
|||||||||||
Amount
|
Fair Value
|
Amount
|
Fair Value
|
|||||||||||
$ | 130,068 | $ | 80,000 | $ | 590,331 | $ | 500,000 |
Differences
between fair value and carrying amount of long-term debt are primarily due to
instruments that provide fixed interest or contain fixed interest rate elements.
Inherently, such instruments are subject to fluctuations in fair value due to
subsequent movements in interest rates that are available to the
Company.
NOTE
11. - EARNINGS PER MEMBERSHIP UNIT
The
following table sets forth the computation of basic and diluted earnings per
share for the years ended December 31:
2009
|
2008
|
|||||||
Net
loss
|
$ | (1,226,685 | ) | $ | (736,379 | ) | ||
Denominator
for basic earnings per share-weighted average units
outstanding
|
5,304,423 | 5,238,176 | ||||||
Effect
of dilutive securities:
|
||||||||
warrants
outstanding
|
— | — | ||||||
Denominator
for diluted earnings per unit - weighted average units adjusted
for dilutive securities
|
5,304,423 | 5,238,176 |
- 15
-
NOTE
11. - EARNINGS PER UNIT (CONTINUED)
Loss
per common unit - basic
|
$ | (0.23 | ) | $ | (0.14 | ) | ||
Loss
per common unit- diluted
|
$ | (0.23 | ) | $ | (0.14 | ) |
Securities
outstanding that were excluded from the computation because they would have been
anti-dilutive are as follows:
2009
|
2008
|
|||||||
Debt
convertible into units (number of units)
|
197,679 | 349,439 | ||||||
Warrants
|
1,688,076 | 927,514 |
NOTE
12. - SUBSEQUENT EVENTS
Equity and Debt
Transactions - Subsequent to December 31, 2009 and through October 15,
2010, the Company sold 6,447,792 common Membership Units to members in exchange
for $965,000 in proceeds. The Company also borrowed in the aggregate $230,000 on
an unsecured basis from members, of which $185,000 are short term notes and bear
interest at 15% due as follows: $35,000 due November 1, 2010 and $150,000 due
January 31, 2011. Additionally, an unsecured $45,000 note is due in January 2012
with interest at 10%. The 1,688,076 warrants outstanding at December 31, 2009
have since been exercised.
Assignment of
NAIST’s Patents - Since 2005 the Company has had a relationship with Nara
Institute of Science and Technology, National University Corporation, Nara
Japan, (‘‘NAIST’’) defined under an exclusive license agreement which had been
amended from time to time. Under this agreement, the Company funded research and
development and was granted exclusive rights to certain patent families. The
Company was required to pay annual license fees and fund related patent costs.
In March 2010 NAIST assigned all of its international patents to the Company
that had been the subject of the license agreement for payment of amounts owed
by the Company to NAIST and included in accounts payable as of December 31,
2009. This transaction relieved the Company’s obligation to pay annual license
fees of approximately $85,000 through 2027, the date patents would expire.
Accordingly, these license fees are excluded from the Company’s commitments in
future years discussed in Note 9.
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 to reflect this split.
- 16
-