22nd Century Group, Inc. (Form: 10-K, Received: 01/30/2014 14:36:39)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

x Annual Report under Section 13 or 15(d) of the Securities

Exchange Act of 1934

For the fiscal year ended December 31, 2013

¨ Transitional Report under Section 13 or 15(d) of the

Securities Exchange Act of 1934

Commission File Number: 000-54111

22nd Century Group, Inc.

(Exact name of registrant as specified in its charter)

Nevada	98-0468420
(State or other jurisdiction	(IRS Employer
of incorporation)	Identification No.)

9530 Main Street, Clarence, New York 14031

(Address of principal executive offices)

(716) 270-1523

Registrant’s telephone number, including area code

Securities registered under Section 12(b) of the Act: None

Securities registered under Section 12(g) of the Act:

Common Stock (Par Value - $0.00001 per share)

Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act

Yes ¨ No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act.

Yes ¨ No x

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files)

Yes x No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.

Large Accelerated Filer ¨

Accelerated Filer ¨

Non-Accelerated Filer ¨

Smaller Reporting Company x

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Act).Yes ¨ No x

As of June 28, 2013, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate value of the registrant’s common stock (excluding the 19,040,893 shares held by affiliates), based upon the $0.71 price at which such common stock was last sold on June 28, 2013, was approximately $18.3 million.

As of January 28, 2014, there were 58,252,770 shares of common stock issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant's Proxy Statement for its 2014 Annual Meeting of Stockholders are incorporated herein by reference in Part III of this Annual Report on Form 10-K. Such Proxy Statement will be filed with the Securities and Exchange Commission within 120 days of December 31, 2013.

22nd Century Group, Inc.

Table of Contents

	PART I
Item 1.	Business.	3
Item 1A.	Risk Factors.	21
Item 1B.	Unresolved Staff Comments.	33
Item 2.	Properties.	33
Item 3.	Legal Proceedings.	33
Item 4.	Mine Safety Disclosures	33
	PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.	33
Item 6.	Selected Financial Data.	34
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.	35
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk.	41
Item 8.	Financial Statements and Supplementary Data.	41
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.	41
Item 9A.	Controls and Procedures.	42
Item 9B.	Other Information.	42
	PART III
Item 10.	Directors, Executive Officers and Corporate Governance.	43
Item 11.	Executive Compensation.	44
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.	44
Item 13.	Certain Relationships and Related Transactions, and Director Independence.	44
Item 14.	Principal Accounting Fees and Services	44
	PART IV
Item 15.	Exhibits and Financial Statement Schedules.	44

	1

Cautionary Note Regarding Forward-Looking Statements

This Annual Report on Form 10-K contains forward-looking statements concerning our business, operations and financial performance and condition as well as our plans, objectives and expectations for our business operations and financial performance and condition that are subject to risks and uncertainties. All statements other than statements of historical fact included in this Annual Report on Form 10-K are forward-looking statements. You can identify these statements by words such as “aim,” “anticipate,” “assume,” “believe,” “could,” “due,” “estimate,” “expect,” “goal,” “intend,” “may,” “objective,” “plan,” “potential,” “positioned,” “predict,” “should,” “target,” “will,” “would” and other similar expressions that are predictions of or indicate future events and future trends. These forward-looking statements are based on current expectations, estimates, forecasts and projections about our business and the industry in which we operate and our management's beliefs and assumptions. These statements are not guarantees of future performance or development and involve known and unknown risks, uncertainties and other factors that are in some cases beyond our control. All forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those that we expected, including:

Our ability to manage our growth effectively;

· Our ability to comply with existing and new government regulations;

Our ability to retain key personnel;

· Our ability to enter into additional licensing transactions;

The prospect of one of our subsidiaries becoming a member of the U.S. Master Settlement Agreement;

· Our ability to achieve profitability;

The potential for our clinical trials to produce negative or inconclusive results;

· Our ability to obtain significant revenue for our tobacco products in the U.S.;

Our ability to obtain U.S. Food and Drug Administration (“FDA”) clearance for our potentially modified risk tobacco products and FDA approval for our X-22 smoking cessation aid;

· Our ability to gain market acceptance for our products;

Our ability to compete with competitors that may have greater resources than us;

· The potential for our competitors to develop products that are less expensive, safer or more effective than ours;

The potential exposure to product liability claims, product recalls and other claims; and

· Our ability to adequately protect our intellectual property and to avoid infringement on rights of third parties.

For the discussion of these risks and uncertainties and others that could cause actual results to differ materially from those contained in our forward-looking statements, please refer to “Risk Factors” in this Annual Report on Form 10-K. The forward-looking statements included in this Annual Report on Form 10-K are made only as of the date hereof. We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as otherwise required by law.

Unless the context otherwise requires, references to the “Company” “we” “us” and “our” refer to 22nd Century Group, Inc., a Nevada corporation, and its direct and indirect subsidiaries.

	2

PART I

Item 1.

Business.

Background

22nd Century Group, Inc. was incorporated under the laws of the State of Nevada on September 12, 2005 under the name Touchstone Mining Limited. On January 25, 2011, we entered into a reverse merger transaction with 22nd Century Limited, LLC, which we refer to herein as the Merger. Upon the closing of the Merger, 22nd Century Limited, LLC became our wholly-owned subsidiary. After the Merger, we succeeded to the business of 22nd Century Limited, LLC as our sole line of business.

22nd Century Limited, LLC was originally formed as a New York limited liability company on February 20, 1998 as 21st Century Limited, LLC and subsequently merged with a newly-formed Delaware limited liability company, 22nd Century Limited, LLC, on November 29, 1999. Since inception, 22nd Century Limited, LLC has used biotechnology to regulate the nicotine content in tobacco plants.

Business Overview

22nd Century Limited, LLC (“22nd Century Ltd”), our wholly-owned subsidiary, is a plant biotechnology company focused on tobacco harm reduction and smoking cessation products produced from modifying the nicotine content in tobacco plants through genetic engineering and plant breeding. We exclusively control 114 issued patents and an additional 38 patent applications; of these, we own 13 issued patents plus 25 patent applications and we license the remaining patents and patent applications on an exclusive basis. Goodrich Tobacco Company, LLC (“Goodrich Tobacco”) and Hercules Pharmaceuticals, LLC (“Hercules Pharmaceuticals”) are subsidiaries of 22nd Century Ltd. Goodrich Tobacco is focused on commercial tobacco products and potentially reduced-risk or modified risk tobacco products. Hercules Pharmaceuticals is focused on X-22, a prescription smoking cessation aid in development.

Our Strategy

Our long-term focus is the research, development, licensing, manufacturing, and worldwide sales and distribution of our products to reduce the harm caused by smoking. Annual worldwide tobacco product sales, cigarettes and smokeless products, are approximately $700 billion and 90 percent are cigarette sales according to Euromonitor International. Worldwide smoking prevalence has decreased in recent years, but the number of cigarette smokers worldwide has increased to approximately 1 billion due to population growth, according to a 2013 research report from the Institute for Health Metrics and Evaluation (IHME) at the University of Washington.

We believe that the tobacco industry is at the beginning of a paradigm shift towards the development and commercialization of reduced-risk tobacco products which represent a significant step toward achieving the public health objective of harm reduction. Our 15 years of research and development on the tobacco plant, mainly on the nicotine biosynthetic pathway, uniquely positions us to become a major benefactor of this paradigm shift developing in the tobacco industry. Our technology has created, and will continue to develop, a pipeline of products. We are primarily involved in the following activities:

	·	The international licensing of 22nd Century Ltd’s technology, proprietary tobaccos, trademarks;
	·	The manufacture, marketing and international distribution of RED SUN and MAGIC proprietary cigarettes;
	·	The production of SPECTRUM research cigarettes for the National Institute on Drug Abuse (“NIDA”);
	·	The research and development of potentially reduced-risk or modified risk tobacco products;
	·	The development of X-22 , a prescription-based smoking cessation aid consisting of very low nicotine (“VLN”) cigarettes; and
	·	The pursuit of necessary regulatory approvals and clearances from the FDA to market in the U.S X-22 as a prescription smoking cessation aid and BRAND A and BRAND B as reduced-risk or Modified Risk Cigarettes.

We believe our proprietary technology, tobaccos and products will generate multiple significant revenue streams from licensing of our technology and tobacco and from the sales of our products.

Our Technology

Our proprietary technology enables us to decrease or increase the level of nicotine (and other nicotinic alkaloids such as nornicotine, anatabine and anabasine) in tobacco plants by decreasing or increasing the expression of gene(s) responsible for nicotine production in the tobacco plant using genetic engineering. The basic techniques include, but are not limited to those that are used in the production of genetically modified (“GM”) varieties of other crops, which are also known as “biotech crops.” However, our proprietary technology can also be implemented without the resulting plants being GM, as long as no foreign DNA (not inherent to a plant species such as Nicotiana tabacum ) is present in the engineered plant.

The year 2012 was the 17th year of commercialization of biotech crops. Biotech crop hectares increased by an unprecedented 100-fold from 1.7 million hectares in 1996 to 170.3 million hectares in 2012, according to the International Service for the Acquisition of Agri-Biotech Applications. The top biotech crops in order of hectarage are the following: soybean, maize, cotton, and canola. Alfalfa, sugarbeet, papaya, squash, poplar, tomato, sweet pepper and tobacco are other biotech crops grown in 2012. Of the 28 countries which planted biotech crops in 2012, 20 were developing countries and 8 were industrial countries. The 5 leading developing countries are Brazil, Argentina, India, China and South Africa, planting 46% of global biotech crops in 2012. The top 5 countries planting biotech crops are United States, Brazil, Argentina, Canada and India.

Approximately 90% of the corn and soybeans grown in the United States are GM. The only components of the technology that are distinct from those in commercialized GM varieties of major crops are segments of tobacco genes (DNA sequences) that are also present in all conventional tobacco plants. GM tobacco that we use in our commercial products has been deregulated by the USDA. Thus, plants may be grown and used in products in the United States without legal restrictions or labeling requirements related to the genetic modification. Nevertheless, our proprietary tobacco is grown only by farmers under contracts that require segregation and prohibit transfer of material to other parties.

During the development of genetically-engineered plant varieties, many candidate plant lines are evaluated in the field in multiple locations over several years, as in any other variety development program. This is carried out in order to identify lines that have not only the specific desired trait, e.g., very low nicotine, but have overall characteristics that are suitable for commercial production of the desired product. This process allows us to determine if there are undesirable effects of the genetic modification approach or the specific genetic modification event, regardless of whether the effects are anticipated or unanticipated. For example, since nicotine is known to be an insecticide that is effective against a wide range of insects, reduction of nicotine content in the plants may be expected to affect susceptibility to insect pests. While there are differences in the susceptibility of VLN tobacco to some insects, all tobacco is attacked by a number of insects. The measures taken to control insect pests of conventional tobacco are adequate to control insect pests in VLN tobacco.

Once a genetically-engineered tobacco plant with the desired characteristics is obtained, each plant can produce hundreds of thousands of seeds. When each seed is germinated, the resulting tobacco plant has characteristics similar to the parent and sibling plants and the nicotine content of these plants generally fall within a narrow range. Tobacco products with either low or high nicotine content are easily produced through this method. For example, one of our proprietary tobacco varieties contains the lowest nicotine content of any tobacco ever commercialized, with approximately 97% less nicotine than tobacco in leading “light” cigarette brands. This proprietary tobacco grows with virtually no nicotine without adversely affecting the other leaf constituents important to a cigarette’s characteristics, including taste and aroma.

Our Intellectual Property

Our proprietary technology is covered by 12 patent families consisting 114 issued patents and an additional 38 patent applications; of these, we own 13 issued patents plus 25 patent applications and we license the remaining patents and patent applications on an exclusive basis from third parties. A “patent family” is a set of patents granted in various countries to protect a single invention. Our patent coverage in the United States and China, two of the most valuable smoking cessation and cigarette markets in the world, consists of 16 issued patents and 8 pending applications and 6 issued patents and 3 pending patent applications, respectively. We have exclusive rights to all uses of the following genes responsible for nicotine content in tobacco plants: NBB , QPT , A622 , MPO and several transcription factor genes. We have exclusive rights to plants with altered nicotine content produced from modifying expression of these genes and tobacco products produced from these plants. We also have the exclusive right to license and sublicense these patent rights. The patents owned by or exclusively licensed to us are issued in 78 countries where at least 75% of the world’s smokers reside.

We own various registered trademarks in the United States. We also have exclusive plant variety rights in the United States (plant variety protection certificates are issued by the U.S. Department of Agriculture) and Canada. A PVP certificate prevents anyone other than the owner/licensee from planting, propagating, selling, importing and exporting a plant variety for twenty (20) years in the U.S. and generally for twenty (20) years in other member countries of the International Union for the Protection of New Varieties of Plants, known as UPOV, an international treaty concerning plant breeders’ rights. There are currently more than 70 countries that are members of UPOV.

	4

Licensing our technology and tobacco

We have been in negotiations with various parties in the tobacco and pharmaceutical industries for licensing its technology and products since early 2012. On October 1, 2013, 22nd Century Ltd entered into a Research License and Commercial Option Agreement (the “BAT Research Agreement”) with British American Tobacco (Investments) Limited (“BAT”), a subsidiary of British American Tobacco plc.

Under the terms of the BAT Research Agreement, BAT receives an exclusive worldwide license to certain patent rights (subject to worldwide rights retained by 22nd Century Ltd for use in its own brands) and licensed intellectual property rights (as such terms are defined in the BAT Research Agreement) of 22nd Century Ltd within the field of use as defined in the BAT Research Agreement) for a period of up to four (4) years (the “Research Term”). During the Research Term, BAT also has an option, which can be exercised by BAT at any time during the Research Term, to obtain an exclusive worldwide license (subject to worldwide rights retained by 22nd Century Ltd for use in its own brands) to commercialize certain products derived from utilizing the patent rights and licensed intellectual property rights under the terms of a commercial license agreement (the “Commercial License”). BAT and the Company also agreed to collaborate with each other as each party engages in its own independent research during the term of the Research Agreement.

Simultaneous with the signing of the BAT Research Agreement, BAT paid 22nd Century Ltd a non-refundable $7.0 million. Further, 22nd Century Ltd may receive payments from BAT of up to an additional $7.0 million during the Research Term in the event certain milestones are met by BAT with respect to its research and development of the patent rights and licensed intellectual property rights licensed by 22nd Century Ltd to BAT. There are four separate milestones, two of which BAT would pay 22nd Century Ltd $2.0 million for each milestone achieved, and two of which BAT would pay 22nd Century Ltd $1.5 million for each milestone achieved. BAT may terminate the BAT Research Agreement at any time, subject to the requirements for certain payments to 22nd Century Ltd by BAT upon termination as set forth therein. 22nd Century Ltd may also terminate the BAT Research Agreement in the event of certain uncured breaches of the BAT Research Agreement as set forth therein.

BAT also granted to 22nd Century Ltd a worldwide license to any and all registered research results (as such term is defined in the BAT Research Agreement) developed and owned by BAT which results or arises from any research, development or other activities of BAT under the BAT Research Agreement, with the terms of such license from BAT to 22nd Century Ltd (i) to be on commercially reasonable terms to be negotiated in good faith between the parties, but in any event on terms which are no more onerous than the terms of the Commercial License, if any, and (ii) to be dependent on what, if any, research results the Company elects to license.

If BAT exercises the option for a worldwide Commercial License, BAT is required to pay 22nd Century Ltd $3.0 million in aggregate annual license fees over a 2-year ramp-up period, and thereafter, a royalty of (i) $100 per metric ton of licensed tobacco that is supplied to, or grown and ready for shipment to, BAT and is affiliates (other than Reynolds American, Inc. and Reynolds’ affiliates) and all other third parties; and (ii) $200 per metric ton of licensed tobacco supplied to, or grown and processed by, BAT’s affiliate Reynolds American, Inc.

The minimum and maximum amount of annual royalties under the terms of the Commercial License, which commence after the two-year ramp-up period from the exercise of the option, are $3.0 million and $15.0 million, respectively for a period of three years. Thereafter, the minimum and maximum annual royalties increase to $5.0 million and $25 million, respectively, until September 28, 2028. Thereafter, no further minimum royalties are due and the maximum annual royalties due remain at $25 million until expiration of the Commercial License.

Beginning three years from the start of the Commercial License, both 22nd Century Ltd and BAT may license/sublicense rights to any unaffiliated third party for use of the technology outside the United States and 22nd Century Ltd and BAT will equally share all profit from all such licensees/sublicensees. Inside the United States, BAT may only sublicense BAT’s commercial rights to Reynolds American Inc. 22nd Century Ltd may sublicense any party in the United States.

British American Tobacco sells product in approximately 180 countries. In 2012, global production of tobacco leaf was approximately 5,700,000 metric tons, of which BAT utilized approximately 10% for BAT’s and its affiliates’ brands.

Our RED SUN and MAGIC Cigarettes

Our subsidiary, Goodrich Tobacco, introduced two super-premium priced cigarette brands, RED SUN and MAGIC , into the U.S. market in the first quarter 2011. Both brands are available in regular and menthol and all brand styles are king size and packaged in hinge-lid hard packs. In 2014, we intend to focus our marketing efforts on tobacconists, smoke shops and tobacco outlets in the U.S. The ban in 2009 by the FDA of all cigarettes with characterizing flavors (with the exception of menthol) has resulted in a product void in these specialty tobacco channels for super-premium priced products. We believe that certain U.S. cigarette wholesalers and retailers will carry our brands, among other reasons, to increase their margins.

	5

Our SPECTRUM Government Research Cigarettes

We were chosen to be a subcontractor for a government contract between RTI International (“RTI”) and the National Institute on Drug Abuse (“NIDA”) to supply altered nicotine research cigarettes (from very low to high) cigarettes to NIDA. These government research cigarettes are distributed to researchers free of charge under the mark SPECTRUM . Goodrich Tobacco has thus far delivered approximately 12 million SPECTRUM research cigarettes. We received a purchase order for an additional 5.5 million SPECTRUM research cigarettes that will be manufactured and shipped in January 2014.

Rationale for and History of Modified Risk Tobacco Products

A substantial number of adult smokers are unable or unwilling to quit smoking. For example, each year one-half of the adult smokers in the United States do not attempt to quit. Nevertheless, we believe the majority of these smokers are interested in reducing the harmful effects of smoking.

In a 2005 analyst report, The Third Innovation, Potentially Reduced Exposure Cigarettes , JP Morgan examined the effects of FDA regulation 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 Tobacco Control Act becoming law in 2009, no regulatory agency or body had the authority to assess potential modified risk tobacco products.

Some major cigarette manufacturers have developed and marketed alternative cigarette products. For example, Philip Morris USA developed an alternative cigarette, called Accord ^® , in which the tobacco is heated rather than burned. R.J. Reynolds Tobacco Company has developed and is marketing an alternative cigarette, called Eclipse ^® , in which the tobacco is primarily heated, with only a small amount of tobacco burned. Philip Morris and RJ Reynolds have indicated that their products may deliver fewer smoke components compared to conventional cigarettes. Both Accord ^® and Eclipse ^® , which are not conventional cigarettes but cigarette-like devices, have only achieved limited sales. Vector Tobacco Inc. (“Vector Tobacco”), our former licensee, has marketed a cigarette offered in three brand styles with reduced levels of nicotine, called Quest ^® . With the exception of Eclipse ^® , the above products are no longer being sold.

Complete cessation from all tobacco and medicinal nicotine products is the ultimate goal of the public health community. However, some public health officials desire to migrate cigarette smokers en masse to medicinal nicotine (also known as NRT) or smokeless tobacco products to replace cigarettes. We believe this is unattainable in the foreseeable future for many reasons, including because the smoking experience is much more complex than simply seeking nicotine. In a 2009 WHO report, statistics demonstrate that approximately 90% of global tobacco users smoke cigarettes. Worldwide cigarette sales (in U.S. dollars) are approximately 12 times greater than sales of smokeless tobacco products and approximately 200 times greater than sales of NRT products. Although a small segment of the smoking population is willing to use smokeless tobacco products in conjunction with cigarettes (known as dual users), a large percentage of smokers is not interested in using smokeless tobacco products exclusively.

There are newer forms of smokeless tobacco products that have been introduced in the market that are less messy to use than chewing tobacco or dry snuff (since spitting is not involved). These products include Swedish-style snus such as Camel ^® snus made by R.J. Reynolds Tobacco Company and dissolvable tobacco products such as Ariva ^® and Stonewall ^® owned by Star Scientific Inc. Although use of such products may be more discreet and convenient than traditional forms of smokeless tobacco, they have the same route of delivery of nicotine as nicotine gums and nicotine lozenges, which have been available over-the-counter in the United States for approximately 30 years and 22 years, respectively, and have not significantly replaced cigarettes.

Cigarette-like devices are being developed by the largest tobacco companies and are referred to as “next generation products” or “NGPs.” These include heat-not-burn cigarettes in which most if not all of the tobacco is heated and not burned resulting in reduced tobacco toxins. At the Morgan Stanley Global Consumer Conference on November 20, 2013, Philip Morris International presented three platforms of NGPs, the first two of which contain tobacco and are heat-not-burn products and the third uses a chemical reaction to generate a nicotine-containing aerosol. On January 10, 2014, Philip Morris International announced an investment of up to €500 million into its first manufacturing facility in the European Union and an associated pilot plant near Bologna, Italy to produce its potentially reduced-risk tobacco products. Once fully operational by 2016, the factory and pilot plant combined are expected to reach annual production capacity of up to 30 billion units.

The Tobacco Control Act and Our Potentially Modified Risk Cigarettes – BRAND A and BRAND B

The 2009 Family Smoking Prevention and Tobacco Control Act (“Tobacco Control Act”) granted the FDA authority over the regulation of all tobacco products. While it prohibits the FDA from banning cigarettes outright, it allows the FDA to require the reduction of nicotine or any other compound in tobacco and cigarette smoke. The Tobacco Control Act also banned all sales in the U.S. of cigarettes with characterizing flavors (other than menthol). As of June 2010, all cigarette companies were required to cease the use of the terms “low tar,” “light” and “ultra light” in describing cigarettes sold in the U.S. Besides numerous other regulations, including certain marketing restrictions, for the first time in history, a U.S. regulatory agency will scientifically evaluate cigarettes that may pose lower health risks as compared to conventional cigarettes.

The Tobacco Control Act establishes procedures for the FDA to regulate the labeling and marketing of cigarettes that (i) reduce exposure to tobacco toxins and (ii) are reasonably likely to pose lower health risks as compared to conventional cigarettes (“Modified Risk Cigarettes”). The Tobacco Control Act requires the FDA to issue specific regulations and guidance regarding applications submitted to the FDA for the authorization to label and market modified risk tobacco products, including Modified Risk Cigarettes. On March 30, 2012, the FDA issued Modified Risk Tobacco Product Applications Draft Guidance. We have been continuing to gather additional information since the FDA’s draft guidance on the subject, including from the FDA, to submit complete applications for our two Modified Risk Cigarette candidates, which we expect to do so in 2014. Depending on how many exposure studies and other information the FDA will require, it is likely that we will require additional capital to complete the entire FDA authorization process for our Modified Risk Cigarettes.

We believe that BRAND A and BRAND B will qualify as Modified Risk Cigarettes and we intend to seek FDA authorization to market BRAND A and BRAND B as Modified Risk Cigarettes. We believe that our BRAND A and BRAND B cigarettes will benefit smokers who are unable or unwilling to quit smoking and who may be interested in cigarettes which reduce exposure to certain tobacco smoke toxins and/or pose a lower health risk than conventional cigarettes. This includes the approximate one-half of the 44 million adult smokers in the United States who do not attempt to quit in a given year. Compared to commercial cigarettes, the tobacco in BRAND A has approximately 95% less nicotine than tobacco in cigarettes previously marketed as “light” cigarettes and BRAND B ’s smoke contains an extraordinary low amount of “tar” per milligram of nicotine.

BRAND A Cigarettes

Compared to commercial tobacco cigarettes, BRAND A has the lowest nicotine content. The tobacco in BRAND A contains approximately 95% less nicotine than tobacco in leading “light” cigarette brands. Clinical studies have demonstrated that smokers who smoke VLN cigarettes containing our proprietary tobacco smoke fewer cigarettes per day resulting in significant reductions in smoke exposure, including “tar,” nicotine and carbon monoxide. Due to the very low nicotine levels, compensatory smoking does not occur with VLN cigarettes containing our proprietary tobacco (Hatsukami et al . 2010).

In a June 16, 2010 press release, Dr. David Kessler, the former FDA Commissioner, recommended that “[t]he FDA should quickly move to reduce nicotine levels in cigarettes to non-addictive levels. If we reduce the level of the stimulus, we reduce the craving. It is the ultimate harm reduction strategy.” Shortly thereafter in a Washington Post article, Dr. Kessler said that the amount of nicotine in a cigarette should drop from about 10 milligrams to less than 1 milligram. BRAND A contains approximately 0.7 milligram of nicotine per cigarette.

A Phase II smoking cessation clinical trial at the University of Minnesota Masonic Comprehensive Cancer Center (Hatsukami et al . 2010) also measured exposure of various smoke compounds in smokers from smoking a VLN cigarette containing our proprietary tobacco over a six (6)-week period. Smokers significantly reduced their smoking as compared to their usual brand of cigarettes. The number of VLN cigarettes smoked per day on average decreased from 19 (the baseline number of cigarettes of smokers’ usual brand) to 12 by the end of the six (6)-week period, even though participants were instructed to smoke ad libitum (as many cigarettes as desired) during treatment. Furthermore, besides significant reductions in other biomarkers, carbon monoxide (CO) levels, an indicator of smoke exposure, significantly decreased from 20 parts per million (baseline) to 15 parts per million. Cotinine, a metabolite and biomarker of nicotine, significantly decreased from 4.2 micrograms/mL (baseline) to 0.2 micrograms/mL. All differences were statistically significant (P<0.05).

We believe these and other results and future exposure studies the FDA will require will result in a modified risk cigarette claim for BRAND A . We further believe smokers who desire to smoke fewer cigarettes per day while also satisfying cravings and reducing exposure to nicotine will find BRAND A beneficial. There is no guarantee that BRAND A will be classified as a Modified Risk Cigarette by the FDA.

	7

BRAND B Cigarettes

Using a proprietary high nicotine tobacco blend in conjunction with specialty cigarette components, BRAND B allows the smoker to achieve a satisfactory amount of nicotine per cigarette while inhaling less “tar” and carbon monoxide. At the same time, we do not expect exposure to nicotine from BRAND B to be significantly higher than some commercially available full flavor cigarette brands. We believe smokers who desire to reduce smoke exposure but are less concerned about nicotine will find BRAND B beneficial. BRAND B has a “tar” yield between typical “light” and “ultra-light” cigarettes, but a nicotine yield of typical full flavor cigarettes.

In a 2001 report, entitled Clearing the Smoke, Assessing the Science Base for Tobacco Harm Reduction , the Institute of Medicine notes that a low “tar”/moderate nicotine cigarette is a viable strategy for reducing the harm caused by smoking. The report states: “Retaining nicotine at pleasurable or addictive levels while reducing the more toxic components of tobacco is another general strategy for harm reduction.” We believe that evaluation of BRAND B in short-term human exposure studies will confirm that exposure to smoke, including certain tobacco smoke toxins and carbon monoxide, is significantly reduced when smoking BRAND B as compared to smoking the leading brands of cigarettes. We believe results from these exposure studies will warrant a modified risk claim for BRAND B . There is no guarantee that BRAND B will be classified as a Modified Risk Cigarette by the FDA.

Tar, Nicotine, and Smoking Behavior

The dependence of many smokers on tobacco is largely due to the properties of nicotine, but the adverse effects of smoking on health are mainly due to other components present in tobacco smoke, including “tar” and carbon monoxide. “Tar” is the common name for the total particulate matter minus nicotine and water produced by the burning of tobacco (or other plant material) during the act of smoking. “Tar” and nicotine are commonly measured in milligrams per cigarette trapped on a Cambridge filter pad under standardized conditions using smoking machines. These results are referred to as “yields” or, more specifically, “tar” yield and nicotine yield.

Individual smokers generally seek a certain amount of nicotine per cigarette and can easily adjust how intensely each cigarette is smoked to obtain a satisfactory amount of nicotine. Smoking of low yield (“light” or “ultra light”) cigarettes compared to high yield (“full flavor”) cigarettes often results in taking more puffs per cigarette, larger puffs and/or smoking more cigarettes per day to obtain a satisfactory amount of nicotine, a phenomenon known as “compensation” or “compensatory smoking.” A report by the National Cancer Institute in 2001 stated that due to compensatory smoking, low yield cigarettes are not safer than full flavor cigarettes, which is the reason that the Tobacco Control Act has banned the use of the terms “low tar,” “light” and “ultra-light” in the U.S. market. Studies have shown, however, that smokers generally do not compensate when smoking cigarettes made with our VLN tobacco, and that smoking VLN cigarettes, such as BRAND A, actually assist smokers to smoke fewer cigarettes per day and reduce their exposure to “tar” and nicotine. Other studies have demonstrated that compensatory smoking (e.g., more and/or larger puffs per cigarette) of low-tar research cigarettes, similar to BRAND B ( though BRAND B was not used in such studies), is greatly curtailed resulting in smokers inhaling less “tar” and carbon monoxide. Additional studies will be necessary to establish whether BRAND B cigarettes achieve similar results.

X-22

X-22 is a tobacco-based botanical medical product for use as an aid to smoking cessation. The X-22 therapy protocol utilized in our sponsored Phase II-B clinical trial calls for the patient to smoke our very low nicotine (“VLN”) cigarettes over a six-week treatment period to facilitate the goal of the patient quitting smoking by the end of the treatment period. We believe this therapy protocol has been successful in independent clinical trials because VLN cigarettes made from our proprietary tobacco satisfy smokers’ cravings for cigarettes while (i) greatly reducing nicotine exposure and nicotine dependence and (ii) extinguishing the association between the act of smoking and the rapid delivery of nicotine. X-22 involves the same smoking behavior as conventional cigarettes and because patients are simply switching to VLN cigarettes for 6 weeks, X-22 does not expose the smoker to any new drugs or new side effects. Our Investigational New Drug Application for X-22 , a kit of VLN cigarettes, was cleared by the FDA in July 2011 and has been updated annually. Our X-22 Phase II-B clinical trial was completed in the first quarter of 2012 and did not demonstrate a statistically significant difference in quitting between X-22 and the active control, a cigarette containing conventional nicotine levels. However, the median number of X-22 cigarettes smoked during the trial was significantly reduced compared to patients’ baseline of usual brand of cigarettes. In evaluating the results of this trial, we believe we may have reduced the nicotine content of X-22 by too great a percentage, to a level less than half the nicotine content of VLN cigarettes used in various independent smoking-cessation clinical trials that have demonstrated that use of VLN cigarettes increases quit rates.

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Due to the limited effectiveness and/or serious side effects of existing FDA-approved smoking cessation products (all of which have been on the market approximately between 8 and 30 years), we believe that if additional clinical trials demonstrate increased smoking cessation rates, X-22 can capture a share of this market by replacing sales and market share from existing smoking cessation aids and expanding the smoking cessation market by encouraging more smokers to attempt to quit smoking. In contrast to the results of our Phase II-B trial results, independent studies have demonstrated that VLN cigarettes increase quit rates, whether used alone, in conjunction with Chantix ^® (varenicline) or nicotine replacement therapy (“NRT”) such as nicotine patches, gums or lozenges.

Hatsukami DK, Kotlyar M, Hertsgaard LA, Zhang Y, Carmella SG, Jensen J, Allen SS, Shields PG, MurphySE, Stepanov I, Hecht SS. 2010. Reduced nicotine content cigarettes: effects on toxicant exposure, dependence and cessation. Addiction 105:343-355.

· Phase II

	·	www.ncbi.nlm.nih.gov/pubmed/23603206

Reduced nicotine content cigarettes and nicotine patch. Hatsukami DK, Hertsgaard LA, Vogel RI, Jensen JA, Murphy SE, Hecht SS, Carmella SG, al'Absi M, Joseph AM, Allen SS. 2013. Reduced nicotine content cigarettes and nicotine patch. Cancer Epidemiol Biomarkers Prev . Jun;22(6):1015-24.

· Phase II

	·	www.ncbi.nlm.nih.gov/pubmed/23603206

Walker N, Howe C, Bullen C, Grigg M, Glover M, McRobbie H, Laugesen M, Parag V, Whittaker R. 2012. The combined effect of very low nicotine content cigarettes, used as an adjunct to usual Quitline care (nicotine replacement therapy and behavioural support), on smoking cessation: a randomized controlled trial. Addiction . 2012 Oct; 107(10):1857-67.

· Phase III/IV

www.ncbi.nlm.nih.gov/pubmed/22594651

Becker KM, Rose JE, Albino AP. 2008. A randomized trial of nicotine replacement therapy in combination with reduced-nicotine cigarettes for smoking cessation. Nicotine Tob Res 10(7):1139-48.

· Phase II

www.ncbi.nlm.nih.gov/pubmed/18629723

Rezaishiraz H, Hyland A, Mahoney MC, O’Connor RJ, Cummings KM. 2007. Treating smokers before the quit date: can nicotine patches and denicotinized cigarettes reduce cravings? Nicotine Tob Res . Nov; 9(11):1139-46.

· Phase II

www.ncbi.nlm.nih.gov/pubmed/17978987

A separate and yet unpublished clinical trial evaluated whether the use of our VLN cigarette in combination with Chantix ^® or in combination with nicotine replacement therapy (“NRT”) increases abstinence rates over the use of Chantix ^® or the use of NRT (NCT01250301). Certain results of this unpublished study were disclosed in a presentation at the 2013 Society for Research on Nicotine and Tobacco (“SRNT”) annual meeting given by Hayden McRobbie, Ph.D. of Queen Mary University of London, Wolfson Institute of Preventative Medicine, who was the principal investigator of the study. Pfizer Inc. was also a collaborator of the study. The study included one hundred smokers who were prescribed varenicline (trademarked Chantix, or Champix outside the U.S.) and one hundred smokers who were prescribed NRT. Half the smokers of each of these groups were randomly selected to also use our VLN cigarettes for the first 2 weeks of treatment. All smokers received 9 weekly behavioral support sessions throughout the 12-week study period. The group that used our VLN cigarettes had a 70% quit rate one week after stopping VLN cigarette use compared to a 53% quit rate of the group not using VLN cigarettes after week 1 (p=0.02). The group that used our VLN cigarettes had a 64% four-week continuous abstinence rate during weeks 3 to 6 compared to a 50% four-week continuous abstinence rate during weeks 1 to 4 (p=0.06). Quit rates at 12 weeks post treatment were not reported in the presentation.

Although we believe that our VLN cigarettes are an effective aid to smoking cessation, we have suspended sponsoring further X-22 clinical trials and are currently in the process of identifying potential joint venture partners or licensees to fund the remaining X-22 clinical trials. Upon identifying a suitable joint venture partner or licensee, we will then request a meeting with the U.S. Food and Drug Administration (“FDA”), and thereafter we may resume our own sponsored X-22 clinical trials. There is no guarantee that we will (ii) identify a joint venture partner or licensee to fund the remaining X-22 clinical trials, (ii) obtain the funds necessary to complete additional clinical trials, (iii) obtain FDA approval, or (iv) capture significant share of the smoking cessation market upon FDA approval.

Within our two product categories, smoking cessation and Modified Risk Cigarettes, the Tobacco Control Act offers us the following specific advantages:

Smoking Cessation Aids

FDA approval must be obtained, as has been the case for decades, before a product can be marketed for quitting smoking. The Tobacco Control Act provides that products for quitting smoking or smoking cessation, such as X-22 , be considered for “Fast Track” designation by the FDA. The “Fast Track” programs of the FDA are intended to facilitate development and expedite review of drugs to treat serious and life-threatening conditions so that an approved product can reach the market expeditiously. We believe that upon completion of a company-sponsored clinical trial demonstrating efficacy, X-22 will qualify for “Fast Track” designation by the FDA. However, there is no guarantee that the FDA will grant “Fast Track” designation to X-22 . Please see section below, titled, Fast Track Development , for a further discussion on the FDA’s “Fast Track” program.

Modified Risk Cigarettes

For the first time in history, a U.S. regulatory agency will scientifically evaluate cigarettes that may pose lower health risks as compared to conventional cigarettes. The Tobacco Control Act establishes procedures for the FDA to regulate the labeling and marketing of modified risk tobacco products, which includes cigarettes that (i) reduce exposure to tobacco smoke toxins and/or (ii) pose lower health risks, as compared to conventional cigarettes (“Modified Risk Cigarettes”). The Tobacco Control Act requires the FDA to issue specific regulations and guidance regarding applications that must be submitted to the FDA for the authorization to label and market Modified Risk Cigarettes. On March 30, 2012, the FDA issued Modified Risk Tobacco Product Applications Draft Guidance. We believe that BRAND A and BRAND B will qualify as Modified Risk Cigarettes. In addition, the Tobacco Control Act allows the FDA to mandate the use of reduced risk technologies in conventional tobacco products and cigarettes (e.g., Marlboro ^® ), which could create opportunities for us to license our proprietary technology and/or our tobaccos to larger competitors.

We intend to seek FDA authorization to market BRAND A and BRAND B as Modified Risk Cigarettes. The Company has continued to gather additional information since the FDA’s draft guidance on the subject, including from the FDA, to submit complete applications for our two Modified Risk Cigarette candidates. We expect to submit these applications in 2014. Depending on how many exposure studies and other information the FDA will require, it is likely that we will require additional capital to complete the entire FDA authorization process for our Modified Risk Cigarettes. The amount of capital is currently unknown since it is uncertain how many exposure studies the FDA will require for BRAND A and BRAND B .

We believe that BRAND A and BRAND B will achieve significant market share in the global cigarette market among smokers who are unable or unwilling to quit and are interested in reducing the harmful effects of smoking. We believe this new regulatory environment represents a paradigm shift for the tobacco industry. There is no guarantee that we will obtain FDA authorization to market BRAND A and BRAND B as Modified Risk Cigarettes or that we will achieve a significant market share of this specified subgroup of smokers.

Biomass Products

Biomass products are products such as ethanol made from the organic material, usually plants densely grown over a given area. We have funded extensive biomass field trials conducted by NCSU and work on feedstock digestibility and bioconversion at the National Renewable Energy Lab. Bioconversion is the conversion of organic matter into a source of energy, such as ethanol in our own research, through the action of microorganisms. Tobacco has a number of advantages as a starting point for development of novel bioproduct crop systems. Because tobacco is a widely cultivated crop, grown in over 100 countries throughout the world, tobacco agronomy is highly understood. For decades tobacco has been used as a model system for plant biology, and recently the tobacco genome has been mapped. Tobacco plants rapidly sprout back after each harvest and produce large amounts of leaf and total biomass. Tobacco grown for cigarettes yields about 3,000 pounds of cured leaf per acre (~20% moisture) per year from 7,500 tobacco plants. In our field trials in North Carolina, nicotine-free tobacco grown for biomass yields about 100,000 pounds of fresh weight per acre (which equals 10,000 pounds of dry weight) per year with multiple machine harvests from about 80,000 tobacco plants. The results of our biomass studies have been summarized in a comprehensive feasibility study relating to our nicotine-free tobacco biomass crop ( Verfola ) to produce a variety of bioproducts. First, protein and other plant fractions are extracted, and then biofuels and other products are produced from the remaining cellulosic residue.

In 2009, we put our biomass development projects on hold so that our management could focus its attention and resources on our modified risk cigarette business and our X-22 smoking cessation business. We do not plan to move forward with potential biomass business activities until some period of time after FDA approval of X-22 or FDA authorization to market Brand A or Brand B as a Modified Risk Cigarette. We currently are not spending any capital for such potential biomass business activities nor do we have any current plans to do so in the foreseeable future.

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Manufacturing

Goodrich Tobacco has thus far had its cigarette brands contract manufactured by a non-participating manufacturer to the MSA. We are working 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 this end, we are following two parallel tracks for becoming a member of the MSA. First, 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. Goodrich Tobacco’s application has been deemed complete by the TTB, including and a successful TTB field inspection of our manufacturing facility. We expect to receive the permit at any time. On February 26, 2013, Goodrich Tobacco applied to the NAAG to become a participating manufacturer to the MSA.

With respect to the second parallel track, on September 17, 2013, we entered into a Membership Interest Purchase Agreement (“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 from NAAG and certain attorneys general of the settling states of the MSA. NAAG has been discussing the NASCO Transaction with a small working group of settling states of the MSA for which the Company has answered various rounds of questions. The working group has presented the matter to all the settling states with a recommended course of action which the settling states are evaluating. Upon the entry of a revised adherence agreement of NASCO Products, LLC reflecting the NASCO Transaction, we believe we will be able to close the NASCO Transaction. The NASCO Transaction contains termination rights, including a right for us to terminate the Purchase Agreement, at our sole discretion, if the closing shall not have occurred on or before January 31, 2014. At this time we do not expect to invoke our termination rights.

If we are successful through one of these two parallel tracks to become a licensed tobacco products manufacturer and a participating member of the MSA, the distribution potential of RED SUN and MAGIC in the U.S. will be increased. Sales and marketing of our commercial cigarettes have been curtailed in order to limit the complexity and 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 more complex the process becomes and the greater the settlement cost Goodrich Tobacco likely has to pay to become a participating manufacturer of the MSA.

In December 2013, Goodrich Tobacco purchased certain (i) cigarette manufacturing equipment, and (ii) equipment parts, factory items, office furniture and fixtures, vehicles and computer software from the bankruptcy estate of PTM Technologies, Inc. (“PTM”) for $3.22 million. In January 2014, Goodrich Tobacco purchased additional miscellaneous equipment, factory items, office furniture and fixtures, vehicles and computers from the bankruptcy estate of Renegade Tobacco Co. (“Renegade”) for $210,000. PTM and Renegade are related companies located in North Carolina undergoing Chapter 7 liquidation proceedings in the United States Bankruptcy Court for the Middle District of North Carolina.

Research and Development

The majority of our research and development (R&D) since our inception have been outsourced to highly qualified groups in their respective fields. Since 1998, 22nd Century has had multiple R&D agreements with North Carolina State University (“NCSU”) resulting in exclusive worldwide licenses to various patented technologies. We have utilized the same model of many public-sector research organizations which entails obtaining an exclusive option or license agreement to any invention arising out of funded research. In all cases, we fund and control all patent filings as the exclusive licensee. This model of contracting with public-sector researchers has enabled 22nd Century to control R&D costs while achieving our desired results, including obtaining exclusive intellectual property rights relating to our outsourced R&D.

Other R&D partners with the same arrangement have included the National Research Council of Canada, Plant Biotechnology Institute in Saskatoon, Canada (“NRC”) and the Nara Institute of Science and Technology in Nara, Japan (“NAIST”). The majority of this R&D has involved the biosynthesis of nicotine in plants. Our R&D agreements with NCSU, NRC and NAIST expired in 2009. In 2010, NAIST assigned to us all of their worldwide patents and patent applications that were previously licensed to 22nd Century on an exclusive basis. These patents and patent applications were a result of our R&D at NAIST.

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In November 2011, we entered into an R&D agreement with the University of Virginia (“UVA”) relating to nicotine biosynthesis in tobacco plants with a total budget of $500,000 for the period from November 2011 through May 2014. In 2013, we incurred approximately $183,000 of expenses for the R&D agreement at UVA. During the years ended December 31, 2013, 2012 and 2011, we incurred research and development expenses of approximately $744,000, $729,000 and $2,098,000, respectively.

We have committed to an R&D agreement with NCSU relating to nicotine biosynthesis in tobacco plants with a total budget of approximately $163,000 for the period from February 2014 through January 2016. We will also carry out other R&D in 2014 of up to approximately $700,000, including exposure studies for our potential modified risk candidates. Upon identifying a suitable joint venture partner or licensee to fund further X-22 clinical trials, we may carry out additional X-22 clinical trials.

Market

Cigarettes and Smoking Cessation Aids

We believe that our products address unmet needs of smokers; for those who desire to quit, an innovative smoking cessation aid, and for those who are unable or unwilling to quit smoking, cigarettes that may reduce the level of exposure to tobacco toxins.

According to the U.S. Center for Disease Control, the U.S. cigarette market consists of approximately 44 million adult smokers who spent approximately $80 billion in 2012 on approximately 300 billion cigarettes. Worldwide annual manufacturer unit sales are approximately 5.5 trillion cigarettes resulting in annual retail cigarette sales of approximately $620 billion. Annual manufacturer sales of smoking cessation aids in the U.S., all of which must be approved by the FDA, are approximately $1 billion. Outside the United States, the smoking cessation market is in its infancy and is approximately $3 billion.

Approximately 50% of U.S. smokers attempt to quit smoking each year, but only 2% to 5% actually quit smoking in a given year. It takes smokers an average of 8 to 11 “quit attempts” before achieving long-term success. Approximately 95% of “self-quitters” (i.e., those who attempt to quit smoking without any treatment) relapse and resume smoking. The Institute of Medicine, the health arm of the National Academy of Sciences, in a 2007 report concludes: “There is an enormous opportunity to increase population prevalence of smoking cessation by reaching and motivating the 57 percent of smokers who currently make no quit attempt per year.” We believe that our X-22 smoking cessation aid will be attractive to smokers who have been frustrated in their previous attempts to quit smoking using other therapies.

Use of existing smoking cessation aids results in relapse rates that can be as high as 90% in the first year after a smoker initially “quits.” Smokers currently have the following limited choices of FDA-approved products to help them quit smoking:

	⋅	varenicline (Chantix ^® /Champix ^® outside the U.S.), manufactured by Pfizer,
	⋅	bupropion (Zyban ^® ), manufactured by GlaxoSmithKline, and
	⋅	nicotine replacement therapy, or “NRT,” which is available in the U.S. in several forms: gums, patches, nasal sprays, inhalers and lozenges.

Chantix ^® and Zyban ^® are pills and are nicotine free. Chantix ^® , Zyban ^® , the nicotine nasal spray and the nicotine inhaler are available by prescription only in the U.S. Nicotine gums, nicotine patches, and nicotine lozenges are available over-the-counter in the U.S.

Chantix ^® was introduced in the U.S. market in the fourth quarter 2006. Since 2007, Chantix ^® has been the best-selling smoking cessation aid in the United States, with sales, according to Pfizer Inc., of $701 million in 2007, $489 million in 2008, $386 million in 2009, $330 million in 2010 and $326 million in 2011. In July 2009, the FDA required a “Boxed Warning,” the most serious type of warning in prescription drug labeling, for both Chantix ^® and Zyban ^® based on the potential side effects of these drugs. Despite this Boxed Warning, worldwide sales of Chantix ^® in 2009 to 2012 were approximately $700 million, $755 million, $720 million and $670 million, respectively.

Other than Chantix ^® and Zyban ^® , the only FDA-approved smoking cessation therapy in the United States is nicotine replacement therapy (“NRT”). These products consist of gums, patches, nasal sprays, inhalers and lozenges. Nicotine gums and nicotine patches have been sold in the U.S. for approximately 30 years and 22 years, respectively, and millions of smokers have already tried NRT products and failed to stop smoking due to the limited effectiveness of these products. According to Perrigo Company, a pharmaceutical company that sells NRT products, retail sales of NRT products in the United States were $900 million in the fiscal year ended June 30, 2012, up from $800 million in the previous fiscal year.

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Potential Smoking Cessation Aids

Electronic or E-cigarettes

The FDA has not evaluated electronic cigarettes (e-cigarettes) for quitting smoking. The Company is not aware of any published result of a controlled, double-blinded clinical trial of e-cigarettes as a smoking cessation aid that demonstrated statistically significant quit rates compared to a placebo or FDA-approved approved therapeutic for smoking cessation. A study (Bullen et al , 2013) was touted as a success by e-cigarette interest groups and certain members of the press when, in fact, the results demonstrated that an e-cigarette containing nicotine did not achieve statistical significance in quit rates against a placebo e-cigarette (a control without nicotine) or the nicotine patch.

E-cigarettes are included here since there have been unconfirmed claims that these products facilitate cessation. E-cigarettes have been the subject of much controversy for this and various other reasons, including the fact that these products are actually not cigarettes at all but are battery-operated devices filled with nicotine, flavor and other chemicals. They turn nicotine and other chemicals into a vapor that is inhaled. E-cigarettes have nicotine kinetics and delivery very similar to nicotine inhalers, a prescription NRT product already approved by the FDA, which is the reason we believe that using e-cigarettes to quit smoking is not likely to be any more effective than other nicotine replacement products.

In a September 9, 2010 press release, the FDA issued warning letters to five e-cigarette distributors for various violations of the Federal Food, Drug, and Cosmetic Act, including unsubstantiated claims and poor manufacturing practices. The FDA said these e-cigarette companies are illegally marketing their products as tools to help people quit using cigarettes. The FDA believes e-cigarettes “[m]eet the definition of a combination drug-device product under the Federal Food, Drug and Cosmetic Act.” In a letter to the Electronic Cigarette Association of the same date, the FDA said the agency intends to regulate electronic cigarettes and related products in a manner consistent with its mission of protecting the public health. Although the number of adverse event reports for tobacco products submitted to the FDA is low, according to the Center for Tobacco Products more than half (46 of 84) of all reports submitted from 2009 through the first quarter of 2012 were for e-cigarettes (Chen, Nicotine Tob Res 15:615-6, 2013).

The FDA confiscated imports of e-cigarettes and has been in litigation with importers of these products. A federal appeals court ruled on December 7, 2010 that the FDA can only regulate electronic cigarettes as tobacco products rather than as a drug-delivery device. The FDA appealed this decision; however, the U.S. Court of Appeals for the District of Columbia Circuit on January 2011 rejected the FDA’s request to have the court review the December 7, 2010 decision. According to the FDA Public Health Focus web page on e-cigarettes, the Center for Tobacco Products intends to regulate electronic cigarette products that do not make a therapeutic claim as tobacco products. The Department of Health and Humans Services regulatory calendar for 2013 stated that the FDA intended to issue a proposed rule deeming products other than cigarettes, cigarette tobacco, roll-your-own tobacco, and smokeless tobacco that meet the statutory definition of “tobacco product” to be subject to the Federal Food, Drug, and Cosmetic Act by April 2013. The target date was later amended to October 31, 2013, and has not been amended as of January 30, 2014, according to the FDA Unified Agenda. The proposed rule has not been published to date. Any e-cigarette product marketed as a smoking cessation aid would still be regulated as a drug-device product by the Center for Drug Evaluation and Research, and efficacy and safety must be evaluated in controlled clinical trials.

Nicotine Vaccines

Nicotine vaccines are under development in clinical trials. However, they have not yet achieved the efficacy of other FDA-approved smoking cessation therapies. Nicotine itself is not recognized by the body as a foreign compound since the molecule is too small. In order to stimulate the production of antibodies, nicotine must be attached to a carrier to make the vaccine work. Different vaccine development programs use different carriers. Six companies, Cytos Biotechnology AG, Celtic Pharmaceuticals Holdings, Nabi Biopharmaceuticals, L.P. and Independent Pharmaceutica AB, Selecta Biosciences Inc., and Pfizer Inc. have or have had vaccine candidates in clinical trials.

Cytos exclusively licensed its nicotine vaccine candidate to Novartis in 2007 for 35 million Swiss Francs ($30 million) and up to 565 million Swiss Francs ($492 million) in milestone payments and royalties. In October 2009, it was announced that Cytos’ nicotine vaccine candidate failed to show efficacy in a Phase II trial.

GlaxoSmithKline Biologicals SA exclusively licensed Nabi’s nicotine vaccine candidate, NicVAX ^® , in an agreement which was approved by Nabi’s shareholders in March 2010. Together with an upfront non-refundable fee of $40 million paid by GlaxoSmithKline, Nabi is eligible to receive over $500 million in option fees and milestones, not including potential royalties on global sales. Both of Nabi’s Phase III NicVAX ^® clinical trials subsequently failed in 2010 and 2012.

Selecta Biosciences initiated Phase 1 trials of a nicotine vaccine in 2011. Pfizer initiated Phase 1 trials of a nicotine vaccine in 2012.

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These vaccine treatments entail six (6) to seven (7) consecutive monthly injections. Increases in abstinence rates have been reported but only among a minority of trial subjects with the highest levels of anti-nicotine antibodies. To date, not all subjects develop sufficient antibody levels despite receiving multiple injections. Even in those who do develop sufficient antibody levels, cravings for cigarettes are not addressed by this treatment, although the pharmacological reward of nicotine is suppressed. Expectations are that the treatment, if approved, would need to be repeated every 12 to 18 months to assist in preventing relapse.

Sources of Raw Materials

We obtain a large portion of our tobacco leaf requirements from farmers in multiple U.S. states that are under direct contracts with us. The contracts prohibit the transfer of our proprietary seedlings and plant materials to other parties. We purchase the balance of our tobacco requirements through third parties. As we expand our sales and distribution of our current commercial brands and proceed to market with our X-22 smoking cessation aid and BRAND A and BRAND B cigarettes, we plan to scale up the amount of tobacco leaf we obtain directly from farmers under contract.

Sales and Marketing

RED SUN and MAGIC Cigarettes

Goodrich Tobacco introduced two super-premium priced cigarette brands, RED SUN and MAGIC , into the U.S. market in the first quarter 2011. Both brands are available in regular and menthol and all brand styles are king size and packaged in hinge-lid hard packs. In 2014, we intend to focus our marketing efforts on independent retailers, tobacconists, smoke shops and tobacco outlets in the U.S. The ban in 2009 by the FDA of all cigarettes with characterizing flavors (with the exception of menthol) has resulted in a product void in these tobacco channels for super-premium priced products. We believe that certain U.S. cigarette wholesalers and retailers will broadly carry our brands, among other reasons, to increase their margins. To facilitate Goodrich Tobacco becoming a participating manufacturer of the “Master Settlement Agreement” or “MSA,” a settlement among 46 states and the tobacco industry administered by the National Association of Attorneys General (“NAAG”), we have curtailed the sales and marketing of these products. For example, the more RED SUN and MAGIC that was sold while it was produced by a non-participating manufacturer, the greater settlement cost Goodrich Tobacco likely has to pay to become a participating manufacturer of the MSA.

SPECTRUM Government Research Cigarettes

The National Institute on Drug Abuse (“NIDA”), a component of the National Institutes of Health (“NIH”), provides the scientific community with controlled and uncontrolled research chemicals and drug compounds in its Drug Supply Program. NIDA included an option to develop and produce research cigarettes with various levels of nicotine (from very low to high), or Research Cigarette Option, in its request for proposals for a five-year contract for Preparation and Distribution of Research and Drug Products. We have agreed, as a subcontractor to RTI International (“RTI”) in RTI’s contract with NIDA for the Research Cigarette Option, to supply modified nicotine (from very low to high) cigarettes to NIDA. In August 2010, we met with officials from NIDA, FDA, RTI, the National Cancer Institute and the Centers for Disease Control and Prevention to finalize certain aspects of the design of these research cigarettes. These government research cigarettes are distributed to researchers free of charge under the mark SPECTRUM . Goodrich Tobacco has thus far delivered approximately 12 million SPECTRUM research cigarettes. The Company received a purchase order for an additional 5.5 million SPECTRUM research cigarettes that will be manufactured and shipped in January 2014.

X-22 Smoking Cessation Aid

We are currently in the process of identifying potential joint venture partners to fund the remaining X-22 clinical trials. If the FDA approves X-22 as a smoking cessation aid, Hercules Pharmaceuticals intends to enter into arrangements in both the U.S. and international markets with pharmaceutical companies to market and sell X-22 . We plan to seek marketing partners in the U.S. with existing pharmaceutical sales forces that already call on medical and dental offices in their geographic markets.

There are approximately 700,000 physicians in the U.S., including approximately 80,000 general practitioners, many of whom are aware of new medications, even before they achieve FDA approval. There are also approximately 170,000 dentists in the U.S. who can write prescriptions for smoking cessation aids. Upon FDA approval, we plan to develop awareness of X-22 by educating physicians and dentists about our X-22 smoking cessation aid. We intend to advertise in professional journals, use direct mail campaigns to medical professionals, and attend trade shows and professional conferences. We also intend to use internet advertising and pharmacy circulars to reach consumers and to encourage them to ask their physicians and dentists about our X-22 smoking cessation aid. We expect to use public relations to increase public awareness of X-22 . We will seek to use federal and state-funded smoking cessation programs and clinics to inform clinicians and patients about, and encourage the use of, X-22 as a smoking cessation aid. We will also seek to participate in various government-funded programs which purchase approved smoking cessation aids and then distribute these to smokers at no charge or at greatly reduced prices.

BRAND A and BRAND B

We believe that two of our cigarette products in development, which we refer to as BRAND A and BRAND B , will qualify as Modified Risk Cigarettes. Compared to commercial cigarettes, the tobacco in BRAND A has approximately 95% less nicotine than tobacco in cigarettes previously marketed as “light” cigarettes, and BRAND B ’s smoke contains an extraordinary low amount of “tar” per milligram of nicotine.

Smoking Cessation Clinical Trials with VLN Cigarettes

The following independent smoking-cessation clinical trials utilized very low nicotine (“VLN”) cigarettes:

A phase II trial compared the quitting efficacy of a VLN cigarette containing our proprietary tobacco versus a low nicotine cigarette and an FDA-approved nicotine lozenge (4 mg) in a total of 165 patients treated for six (6) weeks (Hatsukami et al. 2010, Addiction 105:343–355). This clinical trial was led by Dr. Dorothy Hatsukami at the University of Minnesota Masonic Comprehensive Cancer Center. Dr. Hatsukami was selected in 2010 as one of the nine voting members of the 12-person Tobacco Products Scientific Advisory Committee (“TPSAC”), within the FDA’s Center for Tobacco Products created under the Tobacco Control Act. Her term on TPSAC has since expired. (TPSAC will make recommendations and issue reports to the FDA Commissioner on tobacco regulatory matters, including but not limited to, the impact of the use of menthol in cigarettes, altering levels of nicotine in tobacco products, and applications submitted to the FDA for modified risk tobacco products).

Results from this trial conclude that patients exclusively using the VLN cigarette containing our proprietary tobacco achieved a 43% quit rate (confirmed four (4)-week continuous abstinence) as compared to a quit rate of 35% for the group exclusively using the FDA-approved nicotine lozenge and a 21% quit rate for the group exclusively using the low nicotine cigarette. Smoking abstinence at the 6-week follow-up after the end of treatment was 47% for the VLN cigarette group, 37% for the nicotine lozenge group and 23% for the low nicotine cigarette group. Furthermore, the VLN cigarette was also associated with greater relief from withdrawal symptoms and cravings of usual brand cigarettes than the nicotine lozenge. Carbon monoxide (CO) levels in patients were tested at each treatment clinic visit to verify smoking abstinence.

Unlike Phase III clinical trials for other FDA-approved smoking cessation aids, four (4) week continuous abstinence in the University of Minnesota Phase II trial was measured after the treatment period, when patients were “off” medication, rather than during the last four weeks of the treatment period. For example, according to the prescription Chantix ^® label, four (4)-week continuous abstinence in the Chantix ^® Phase III clinical trials (the 44 percent quit rate advertised by Pfizer) was measured during the last four weeks of the 12-week treatment period, while patients were still taking Chantix ^® . In one of these Chantix ^® Phase III clinical trials, approximately one-third of those who had been abstinent during the last week of treatment returned to smoking within four weeks after they stopped taking Chantix ^® , and approximately 45% returned to smoking within eight weeks after they stopped taking Chantix ^® .

Patients who used the VLN cigarette over the six (6)-week treatment period significantly reduced their smoking as compared to their usual brand of cigarettes. The number of VLN cigarettes smoked per day on average decreased from 19 (the baseline number of cigarettes of the smoker’s usual brand) to 12 by the end of the six (6)-week treatment period, even though participants in this clinical trial were instructed to smoke ad libitum (as many cigarettes as desired) during treatment. Carbon monoxide (CO) levels, an indicator of smoke exposure, significantly decreased from 20 parts per million (baseline) to 15 parts per million. Cotinine, a metabolite and biomarker of nicotine, significantly decreased from 4.2 micrograms/mL (baseline) to 0.2 micrograms/mL. All differences in the above three measurements were statistically significant (P<0.05).

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A Phase III/IV two-arm smoking-cessation clinical trial of 1,410 treatment-seeking smokers was conducted by the University of Auckland, Clinical Trials Research Unit (Walker et al . 2012 Addiction 107: 857–1867)). The 705 patients who received VLN cigarettes in addition to NRT (patches and/or gum or lozenges) had significantly higher cessation rates at all measured time points (3 weeks, 6 weeks, 3 months and 6 months) than patients treated only with NRT. For those who failed to quit, the median time to relapse was increased to two months in the VLN + NRT group, compared to 13 days in the NRT only group. There was no difference in the frequency of serious adverse events between the groups.

A yet unpublished clinical trial evaluated whether the use of our VLN cigarette in combination with Chantix ^® or in combination with nicotine replacement therapy (“NRT”) increases abstinence rates over the use of Chantix ^® or the use of NRT (NCT01250301). Certain results of this unpublished study were disclosed in a presentation at the 2013 Society for Research on Nicotine and Tobacco (“SRNT”) annual meeting given by Hayden McRobbie, Ph.D. of Queen Mary University of London, Wolfson Institute of Preventative Medicine, who was the principal investigator of the study. Pfizer Inc. was also a collaborator of the study. The study included one hundred smokers who were prescribed varenicline (trademarked Chantix, or Champix outside the U.S.) and one hundred smokers who were prescribed NRT. Half the smokers of each of these groups were randomly selected to also use our VLN cigarettes for the first 2 weeks of treatment. All smokers received 9 weekly behavioral support sessions throughout the 12-week study period. The group that used our VLN cigarettes had a 70% quit rate one week after stopping VLN cigarette use compared to a 53% quit rate of the group not using VLN cigarettes after week 1 (p=0.02). The group that used our VLN cigarettes had a 64% four-week continuous abstinence rate during weeks 3 to 6 compared to a 50% four-week continuous abstinence rate during weeks 1 to 4 (p=0.06). Quit rates at 12 weeks post treatment were not reported in the presentation.

A Phase trial evaluated the efficacy of a VLN cigarette versus an FDA-approved nicotine patch and a combination of VLN cigarette and nicotine patch in 235 smokers (Hatsukami et al. 2013, Cancer Epidemiol Biomarkers Prev 22(6):1015-24). Smokers were randomly assigned to one of three treatment groups: (i) a VLN cigarette (n=79); (ii) a 21 mg nicotine patch (n=80) or (iii) a combination of the 21 mg nicotine patch and a VLN cigarette (n=76). Each group received 6 weeks of treatment, an additional 6 weeks of behavioral treatment, and 3 follow-up visits. Tobacco and nicotine use self-report and carbon monoxide (“CO”) were assessed at each visit. Urinary cotinine was assessed at baseline and at weeks 2, 6, 12, 24 and 36.

Use of the VLN cigarette alone resulted in abstinence rates that did not differ from those for the nicotine patch or the combination treatment at any time point. Although post-treatment abstinence rates did not differ significantly, the median time to relapse to smoking usual brand cigarettes from treatment onset was significantly longer for the combination treatment 7.1 (6.7–7.7) weeks, 2.6 (1.7–5.9, vs. ) weeks for VLN cigarette, and 2.1 (1.6–3.9) weeks for nicotine patch.

The average number of VLN cigarettes smoked per day declined over the treatment period to 16.2 in the VLN cigarette group and 11.3 in the VLN cigarette plus nicotine patch group at 6 weeks, compared to baseline cigarettes/day of 19.4 and 17.7. Nicotine exposure was reduced the most in the VLN cigarette group, falling to 12% of baseline at 6-week treatment period, compared to 46% of baseline for the nicotine patch, 51% for the combination therapy. There were significant declines in levels of urinary NNAL, a metabolite of the tobacco-specific lung carcinogen NNK, in all three groups during treatment, a reduction of 67% in the VLN cigarette group, 81% in the nicotine patch group, and 76% in the VLN cigarette plus patch group.

Gender differences in quitting rates in this study (Hatsukami et al . 2013) were disclosed at the 2013 SRNT annual meeting and differed considerably. CO and cotinine verified continuous abstinence rates at end of treatment (week 12) varied significantly by treatment group and gender (p=0.029 for the interaction). Within the female population at the end of treatment (week 12), the group assigned our VLN cigarette had the highest continuous abstinence rate; the group assigned concurrent use of our VLN cigarette with a 21mg nicotine patch had the next highest continuous abstinence rate followed by the group assigned a 21mg nicotine patch. Within the male population at the end of treatment (week 12), the group assigned a 21mg nicotine patch had the highest continuous abstinence rate; the group assigned concurrent use of our VLN cigarette with a 21mg nicotine patch had the next highest continuous abstinence rate followed by the group assigned our VLN cigarette.

In a separate Phase II clinical trial funded by Vector Tobacco, our former licensee, under Investigational New Drug (“IND”) Application 69,185, a randomized double-blind, active controlled, parallel group, multi-center Phase II smoking cessation clinical trial was conducted to evaluate the quitting efficacy of Quest ^® reduced-nicotine cigarettes as a smoking cessation treatment in 346 patients (Becker et al . 2008, Nicotine & Tobacco Research 10:1139-48). Treatment consisted of smoking three reduced-nicotine cigarette styles (Quest 1 ^® , Quest 2 ^® and Quest 3 ^® ) for two (2) weeks each, with nicotine yields per cigarette of 0.6 mg (a low nicotine cigarette made with a blend of regular tobacco and our proprietary VLN tobacco), 0.3 mg (an extra low nicotine cigarette made with a blend of regular tobacco and our proprietary VLN tobacco) and 0.05 mg (a VLN cigarette made with tobacco only from our proprietary VLN tobacco variety) either in combination with nicotine patch therapy (a nicotine replacement therapy or NRT product) or placebo patches.

In this three-arm clinical trial in which patients were treated over a period of sixteen (16) weeks, use of reduced-nicotine cigarettes in combination with nicotine patches was more effective (the difference was statistically significant) in achieving four (4)-week continuous abstinence than use of nicotine patches alone (32.8% vs. 21.9%), and use of reduced-nicotine cigarettes without nicotine patches yielded an abstinence rate similar (the difference was not statistically significant) to that of nicotine patches (16.4% vs. 21.9%). No serious adverse events were attributable to the investigational product.

A 2008 binding arbitration award, which was completely fulfilled in 2009 by our former licensee, Vector Tobacco, provided us with copies of all of Vector Tobacco’s FDA submissions relating to Vector Tobacco’s IND for Quest ^® and awarded to us a right of reference to Vector Tobacco’s IND for Quest ^® , including all results of Vector’s Phase II clinical trial. This arbitration award allows us to use all such information in our IND with the FDA for our VLN cigarette that contains our same proprietary tobacco that Vector Tobacco used in its IND submissions to the FDA. This arbitration award has been helpful to us with the FDA, since analytical reports produced by Vector Tobacco pertaining to our proprietary tobacco and cigarettes made from our proprietary tobacco are being utilized by us with the FDA.

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A randomized controlled smoking cessation clinical trial using VLN cigarettes was a conducted at Roswell Park Cancer Institute, Buffalo, New York, to investigate the effect of smoking a very low nicotine cigarette (“VLN”) in combination with a nicotine patch for 2 weeks prior to the quit date (Rezaishiraz et al. 2007 Nicotine & Tobacco Research 9:1139-1146). Ninety-eight adult smokers were randomized to two treatments: (i) two (2) weeks of a VLN (Quest 3 ^® ) and 21-mg nicotine patch before the quit date and (ii) a reduced nicotine cigarette (Quest 1 ^® ) during the two (2) weeks before the quit date. After the quit date, all subjects received counseling for smoking cessation and nicotine patch therapy for up to eight (8) weeks (four (4) weeks of 21-mg patches, two (2) weeks of 14-mg patches, and two (2) weeks of 7-mg patches). Group 1, which used the VLN cigarette and a nicotine patch before quitting, had lower combined craving scores during the two (2) weeks before and after the quit date. Self-reported point prevalence of smoking abstinence at the three (3)- and six (6)-month follow-up points was higher in Group 1 (43% vs. 34% and 28% vs. 21%).

A study at Dalhousie University, Halifax, Nova Scotia (Barrett 2010 Behavioural Pharmacology 21:144-52), compared the effects of low nicotine cigarettes and an FDA-approved nicotine inhaler on cravings and smoking behavior of smokers who did not intend to quit. In separate laboratory sessions, each of twenty-two (22) participants used a VLN cigarette (Quest 3 ^® ), a reduced nicotine cigarette (Quest 1 ^® , which contains approximately two-thirds conventional tobacco and one-third VLN tobacco), a nicotine inhaler (10 mg; 4 mg deliverable, Pharmacia), or a placebo inhaler (identical in appearance to the nicotine inhaler, but containing no nicotine). Cravings, withdrawal and mood descriptors were rated before and after a twenty (20)-minute treatment session during which subjects were instructed to smoke two cigarettes or to use an inhaler every 10 seconds. The reduction in the rating of intent to smoke (usual cigarette brand) after using the VLN cigarette (-10.0) was significantly greater than the reduction with the nicotine inhaler (-1.9). Use of the VLN cigarette was also associated with significantly increased satisfaction and relaxation compared to the nicotine inhaler.

Healthcare Reimbursement

The Affordable Care Act and other government and private sector initiatives targeted to potentially limit the growth of healthcare costs are continuing in the U.S. and many other countries where we intend to sell our products, including our X-22 smoking cessation aid. These changes are causing the marketplace to put increased emphasis on the delivery of more cost-effective medical products.

Government healthcare programs in the United States, including Medicare and Medicaid, private healthcare insurance and managed-care plans have attempted to control costs by limiting the amount of reimbursement for which they will pay for particular procedures or treatments. This may create price sensitivity among potential customers for our X-22 smoking cessation aid, even if we obtain FDA approval for it. Some third-party payers must also approve coverage for new or innovative devices or therapies before they will reimburse healthcare providers who use the medical devices or therapies. Even though a new medical product may have been cleared for commercial distribution, we may find limited demand for X-22 until reimbursement approval has been obtained from governmental and private third-party payers.

Competition

In the market for FDA-approved smoking cessation aids, our principal competitors include Pfizer Inc., GlaxoSmithKline PLC, Novartis International AG, and Perrigo Company plc. The industry consists of major domestic and international companies, most of which have existing relationships in the markets into which we plan to sell, as well as financial, technical, marketing, sales, manufacturing, scaling capacity, distribution and other resources, and name recognition substantially greater than ours.

Cigarette companies compete primarily on the basis of product quality, brand recognition, brand loyalty, taste, innovation, packaging, service, marketing, advertising, retail shelf space and price. Cigarette sales can be significantly influenced by weak economic conditions, erosion of consumer confidence, competitors’ introduction of low-price products or innovative products, higher cigarette taxes, higher absolute prices and larger gaps between price categories, and product regulation that diminishes the ability to differentiate tobacco products. Domestic competitors include Philip Morris USA, Reynolds American Inc., Lorillard Inc., Commonwealth Brands, Inc., Liggett Group LCC and Vector Tobacco Inc. International competitors include Philip Morris International, Inc., Japan Tobacco Inc., Imperial Tobacco Group plc, and regional and local tobacco companies; and in some instances, government-owned tobacco enterprises such as the China National Tobacco Corporation.

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Government Regulation

Smoking Cessation Aids

Government authorities in the U.S. and foreign countries extensively regulate the research, development, testing, manufacture, labeling, promotion, advertising, distribution, sampling, marketing and import and export of pharmaceutical products. FDA approval must be obtained, as has been the case for decades, before a product can be marketed for quitting smoking or reducing withdrawal symptoms. In addition, as with all FDA-approved prescription drugs, the FDA must approve the brand name of our X-22 smoking cessation aid. The FDA approval process for smoking cessation aids is similar to that required by the FDA for new drug approvals, although the cost to complete clinical trials for a smoking cessation aid such as X-22 are generally far less than clinical trials for drugs. The primary endpoint of the clinical trial for smoking cessation aids is smoking abstinence, which is generally confirmed by inexpensive, noninvasive biomarker tests. Since potential quitters are already smokers, X-22 will not expose participants in the clinical trials to any new compounds, unlike a new chemical entity, such as Chantix ^® .

The process of obtaining governmental approvals and complying with ongoing regulatory requirements requires the expenditure of substantial time and financial resources. In addition, statutes, rules, regulations and policies may change and new legislation or regulations may be issued that could delay such approvals. If we fail to comply with applicable regulatory requirements at any time during the product development process, approval process, or after approval, we may become subject to administrative or judicial sanctions. These sanctions could include the FDA’s refusal to approve pending applications, withdrawals of approvals, clinical holds, warning letters, product recalls, product seizures, total or partial suspension of our operations, injunctions, fines, civil penalties or criminal prosecution. Any agency enforcement action could have a material adverse effect on us.

The U.S. regulatory scheme for the development and commercialization of new drugs can be divided into three distinct phases: an investigational phase including both preclinical and clinical investigations leading up to the submission of a New Drug Application (“NDA”); a period of FDA review culminating in the approval or refusal to approve the NDA; and the post-marketing period.

Preclinical Phase

The preclinical phase involves the characterization, product formulation and animal testing necessary to prepare an IND Application for submission to the FDA. The IND must be reviewed and authorized by the FDA before the drug can be tested in humans. Once a new drug agent has been identified and selected for further development, preclinical testing is conducted to confirm pharmacological activity, to generate safety data, to evaluate prototype dosage forms for appropriate release and activity characteristics, and to confirm the integrity and quality of the material to be used in clinical trials. A bulk supply of the active ingredient to support the necessary dosing in initial clinical trials must be secured. Data from the preclinical investigations and detailed information on proposed clinical investigations are compiled in an IND submission and submitted to the FDA before human clinical trials may begin. If the FDA does not formally communicate an objection to the IND within 30 days, the specific clinical trials outlined in the IND may go forward.

Clinical Phase

The clinical phase of drug development follows an IND submission and involves the activities necessary to demonstrate the safety, tolerability, efficacy, and dosage of the substance in humans, as well as the ability to produce the substance in accordance with the FDA’s cGMP requirements. Data from these activities are compiled in an NDA requesting approval to market the drug for a given use, or indication. Clinical trials must be conducted under the supervision of qualified investigators in accordance with good clinical practice, and according to IND-approved protocols detailing, among other things, the study objectives and the parameters, or endpoints, to be used in assessing safety and efficacy. Each trial must be reviewed, approved and conducted under the auspices of an independent Institutional Review Board (“IRB”), and each trial, with limited exceptions, must include all subjects’ informed consent. The clinical evaluation phase typically involves the following sequential process:

Phase I clinical trials are conducted in a limited number of healthy subjects to determine the drug’s safety, tolerability, and biological performance. The total number of subjects in Phase I clinical trials varies, but is generally in the range of 20 to 80 people (or less in some cases, such as drugs with significant human experience).

Phase II clinical trials involve administering the drug to subjects suffering from the target disease or condition to evaluate the drug’s potential efficacy and appropriate dose. The number of subjects in Phase II trials is typically several hundred subjects or less.

Phase III clinical trials are performed after preliminary evidence suggesting effectiveness has been obtained and safety, tolerability, and appropriate dosing have been established. Phase III clinical trials are intended to gather additional data needed to evaluate the overall benefit-risk relationship of the drug and to provide adequate instructions for its use. Phase III trials usually include several hundred to several thousand subjects.

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Throughout the clinical testing phase, samples of the product made in different batches are tested for stability to establish shelf life constraints. In addition, increasingly large-scale production protocols and written standard operating procedures must be developed for each aspect of commercial manufacturing and testing.

The clinical trial phase is both costly and time-consuming, and may not be completed successfully within any specified time period, if at all. The FDA closely monitors the progress of each of the three phases of clinical trials that are conducted under an IND and may, at its discretion, reevaluate, alter, suspend, or terminate the testing at any time for various reasons, including a finding that the subjects or patients are being exposed to an unacceptable health risk. The FDA can also request additional clinical testing as a condition to product approval. Additionally, new government requirements may be established that could delay or prevent regulatory approval of our products under development. Furthermore, institutional review boards, which are independent entities constituted to protect human subjects in the institutions in which clinical trials are being conducted, have the authority to suspend clinical trials in their respective institutions at any time for a variety of reasons, including safety issues.

New Drug Application and Review

After the completion of Phase III clinical trials, the sponsor of the new drug submits an NDA to the FDA requesting approval to market the product for one or more indications. An NDA is a comprehensive, multi-volume application that includes, among other things, the results of all preclinical and clinical studies, information about the drug’s composition, and the sponsor’s plans for producing, packaging, and labeling the drug. In most cases, the NDA must be accompanied by a substantial user fee. The FDA has 60 days after submission to review the completeness and organization of the application, and may refuse to accept it for continued review, or refuse to file, if the application is found deficient. After filing, the FDA reviews an NDA to determine, among other things, whether a product is safe and effective for its intended use. Drugs that successfully complete NDA review may be marketed in the United States, subject to all conditions imposed by the FDA.

Prior to granting approval, the FDA generally conducts an inspection of the facilities, including outsourced facilities that will be involved in the manufacture, production, packaging, testing and control of the drug for cGMP compliance. The FDA will not approve the application unless cGMP compliance is satisfactory. If the FDA determines that the marketing application, manufacturing process, or manufacturing facilities are not acceptable, it will outline the deficiencies in the submission and will often request additional testing or information. Notwithstanding the submission of any requested additional information, the FDA ultimately may decide that the marketing application does not satisfy the regulatory criteria for approval and refuse to approve the application by issuing a “not approvable” letter.

The length of the FDA’s review can range from a few months to several years or more. Once an NDA is in effect, significant changes such as the addition of one or more new indications for use generally require prior approval of a supplemental NDA including additional clinical trials or other data required to demonstrate that the product as modified remains safe and effective.

Fast Track Development

The Food and Drug Administration Modernization Act of 1997 (the “Modernization Act”), establishes a statutory program for relatively streamlined approval of “Fast Track” products, which are defined under the Modernization Act as new drugs or biologics intended for the treatment of a serious or life-threatening condition that demonstrates the potential to address unmet medical needs for this condition. Fast Track status requires an official designation by the FDA. The Tobacco Control Act provides that products for smoking cessation, such as X-22 , be considered for “Fast Track” designation by the FDA.

A product that receives Fast Track designation is eligible for (i) more frequent meetings with the FDA to discuss the drug’s development plan and ensure collection of appropriate data needed to support drug approval, and (ii) more frequent written correspondence from the FDA about such things as the design of the proposed clinical trials. A Fast Track product is also eligible for Rolling Review, in which sections of the NDA can be submitted for review by the FDA before the entire application is completed. A Fast Track product would ordinarily meet FDA criteria for Priority Review. The FDA goal for reviewing a drug with Priority Review status is six months from the filing of the NDA.

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Post-Approval Phase

Once the FDA has approved a new drug for marketing, the product becomes available for physicians to prescribe in the U.S. After approval, we must comply with post-approval requirements, including ongoing compliance with cGMP regulations, delivering periodic reports to the FDA, submitting descriptions of any adverse reactions reported, and complying with drug sampling and distribution requirements. We are required to maintain and provide updated safety and efficacy information to the FDA. We must also comply with requirements concerning advertising, product promotions, and labeling.

Modified Risk Cigarettes

The Tobacco Control Act, which became law in June 2009, prohibits the FDA from banning cigarettes outright or mandating that nicotine levels be reduced to zero. However, among other things, it allows the FDA to require the reduction of nicotine or any other compound in cigarettes. In 2009, the Tobacco Control Act banned all sales in the United States of cigarettes with flavored tobacco (other than menthol). As of June 2010, all cigarette companies were required to cease using the terms “low tar,” “light” and “ultra light” in describing cigarettes sold in the United States. We believe this new regulatory environment represents a paradigm shift for the tobacco industry and will create opportunities for us in marketing BRAND A and BRAND B and in licensing our proprietary technology and/or tobaccos to larger competitors.

For the first time in history, a U.S. regulatory agency will scientifically evaluate cigarettes that may pose lower health risks as compared to conventional cigarettes. The Tobacco Control Act establishes procedures for the FDA to regulate the labeling and marketing of modified risk tobacco products, which includes cigarettes that (i) reduce exposure to tobacco smoke toxins and/or (ii) pose lower health risks, as compared to conventional cigarettes (“Modified Risk Cigarettes”). The Tobacco Control Act requires the FDA to issue specific regulations and guidance regarding applications that must be submitted to the FDA for the authorization to label and market Modified Risk Cigarettes. We believe that BRAND A and BRAND B will qualify as Modified Risk Cigarettes. We will need significant additional capital to complete the FDA authorization process for our Modified Risk Cigarettes. The amount of capital is currently unknown since it is uncertain how many exposure studies the FDA will require for BRAND A and BRAND B . In addition, the Tobacco Control Act allows the FDA to mandate the use of reduced risk technologies in conventional tobacco products and cigarettes (e.g., Marlboro ^® ) which could create opportunities for us to license our proprietary technology and/or our tobaccos to larger competitors.

In addition to providing our SPECTRUM cigarettes to NIDA for researchers, we have been directly supplying our proprietary cigarettes to researchers so that additional studies can be conducted to obtain additional information on our products. We expect this information will assist us, along with our own funded studies, in obtaining the necessary FDA authorizations to market BRAND A and BRAND B as Modified Risk Cigarettes and to obtain FDA approval for X-22 as a prescription smoking cessation aid.

Employees

We currently employ nine (9) people and we consider our employee relations to be good.

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Item 1A.

Risk Factors.

You should carefully consider the risk factors set forth below and in other reports that we file from time to time with the Securities and Exchange Commission and the other information in this Annual Report on Form 10-K. The matters discussed in the risk factors, and additional risks and uncertainties not currently known to us or that we currently deem immaterial, could have a material adverse effect on our business, financial condition, results of operation and future growth prospects and could cause the trading price of our common stock to decline.

Risks Related to Our Business and Operations

We have had a history of losses, and we may be unable to achieve and sustain profitability.

We have experienced net losses of approximately $26.1 million, $6.7 million and $1.3 million during the years ended December 31, 2013, 2012 and 2011, respectively. Although we experienced operating income and positive cash flow from operating activities for the year ending December 31, 2013, such results were primarily due to $7,000,000 of royalty revenue received from a worldwide Research License and Commercial Option agreement with BAT. At December 31, 2013, we had current assets of $7,744,115, current liabilities of $984,334, and cash on hand of $5,830,599. We believe the cash balance is adequate to sustain operations and meet all current obligations as they come due for a period in excess of 12 months. Excluding contract growing of our proprietary tobacco with farmers, extraordinary expenses such as potential clinical trials and additional factory start-up costs, our monthly cash expenditures are approximately $200,000. While our current cash balance is adequate to sustain operations for a period in excess of 12 months, generating net income in the future will depend on our ability to successfully operate our cigarette manufacturing facility, sell and market our proprietary tobacco products and generate additional royalty revenue from the licensing our intellectual property. There is no guarantee that we will be able to achieve or sustain profitability in the future. An inability to successfully achieve profitability may decrease our long-term viability.

We have had a history of negative cash flow, and our ability to sustain positive cash flow is uncertain.

We had negative cash flow from operating activities, before cash used in investing activities and cash from financing activities, of approximately $1.8 million and $3.4 million during the years ended December 31, 2012 and 2011, respectively. As indicated above, we believe our cash on hand is adequate to sustain operations and meet all current obligations as they come due for a period in excess of 12 months. Continued generation of positive cash flow from operations will depend on our ability to successfully implement the net income generating activities discussed in the previous risk factor discussion. An inability to successfully implement our net income producing initiatives may decrease our long-term viability.

Our limited operating history makes it difficult to evaluate our current business and future prospects.

We have been in existence since 1998, but our activities have been limited primarily to licensing and funding research and development activities. Our limited operating history may make it difficult to evaluate our current business and our future prospects. We have encountered and will continue to encounter risks and difficulties frequently experienced by growing companies in rapidly changing industries, including increasing expenses as we continue to grow our business. If we do not manage these risks successfully, our business will be harmed.

We have no experience in managing growth. If we fail to manage our growth effectively, we may be unable to execute our business plan or address competitive challenges adequately.

We currently have nine employees. Any growth in our business will place a significant strain on our managerial, administrative, operational, financial, information technology and other resources. We intend to further expand our overall business, customer base, employees and operations, which will require substantial management effort and significant additional investment in our infrastructure. We will be required to continue to improve our operational, financial and management controls and our reporting procedures and we may not be able to do so effectively. As such, we may be unable to manage our growth effectively.

Our working capital requirements involve estimates based on demand expectations and may increase beyond those currently anticipated, which could harm our operating results and financial condition.

We have no experience in selling Modified Risk Cigarettes or smoking cessation products on a commercial basis. As a result, we intend to base our funding and inventory decisions on estimates of future demand. If demand for our products does not increase as quickly as we have estimated, our inventory and expenses could rise, and our business and operating results could suffer. Alternatively, if we experience sales in excess of our estimates, our working capital needs may be higher than those currently anticipated. Our ability to meet any demand for our products may depend on our ability to arrange for additional financing for any ongoing working capital shortages, since it is likely that cash flow from sales will lag behind our investment requirements.

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We may be unable to become a participating member of the MSA, which would result in Goodrich Tobacco continuing to sell its products as a non-participating member non-participating member of the MSA

We are working 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”). As a participating member of the MSA, the distribution potential of RED SUN and MAGIC in the U.S. will be facilitated and likely increased. Goodrich Tobacco has thus far had its cigarette brands contract manufactured by a non-participating manufacturer to the MSA. Sales and marketing of our commercial cigarettes have been curtailed in order to limit the complexity and 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 more complex the process becomes and the greater the settlement cost Goodrich Tobacco likely has to pay to become a participating manufacturer of the MSA. There can be no assurance that we will be able to become a member of the MSA. Failure to become a member of the MSA will result in decreased sales potential of our products in the U.S.

We have limited experience in operating and managing a manufacturing facility.

We have limited experience operating and managing a manufacturing facility. The manufacture of products are subject to strict quality control, testing and record keeping requirements, and continuing obligations regarding the submission of safety reports and other post-market information. In addition, the manufacturing of our own products will be expensive to operate without sufficient production volume. If we are unable to successfully manufacture or sell our products, we will still be liable for the costs associated with operating a manufacturing facility. Accordingly, the operation of such manufacturing facility could have a material adverse effect on our results of operations.

We have suspended further clinical trials for FDA approval of our X-22 smoking cessation aid and we will likely require additional capital before we can complete the FDA authorization process for our Modified Risk Cigarettes.

We have suspended further clinical trials for FDA approval of our X-22 smoking cessation aid until we identify a suitable joint venture partner or licensee willing to fund further X-22 clinical trials. At that time we may resume our own sponsored X-22 clinical trials. There is no guarantee that we will identify a joint venture partner or licensee willing to fund further X-22 clinical trials. We estimate the cost of completing a Phase II trial will be approximately $2 million and the cost of completing two Phase III trials to be approximately $15 million. We will likely require additional capital in the future before we can complete the FDA authorization process for our Modified Risk Cigarettes. The cost of completing the FDA authorization process for each of our two potential Modified Risk Cigarettes is difficult to estimate since it is currently unknown exactly what the FDA will require, including the number and size of exposure studies. If we raise additional funds through the issuance of equity securities to complete the FDA authorization process for our Modified Risk Cigarettes, our stockholders may experience substantial dilution, or the equity securities may have rights, preferences or privileges senior to those of existing stockholders. If we raise additional funds through debt financings, these financings may involve significant cash payment obligations and covenants that restrict our ability to operate our business and make distributions to our stockholders. We also could elect to seek funds through arrangements with collaborators or licensees. To the extent that we raise additional funds through collaboration and licensing arrangements, it may be necessary to relinquish some rights to our technologies or our potential products or grant licenses on terms that are not favorable to us.

If we choose to resume and fund our own clinical trials for FDA approval of our X-22 smoking cessation product and we cannot raise additional capital on acceptable terms, we may not be able to, among other things:

• complete clinical trials of our X-22 smoking cessation aid;

• undertake the steps necessary to seek FDA authorization of our Modified Risk Cigarettes;

• develop or enhance our potential products or introduce new products;

• expand our development, sales and marketing and general and administrative activities;

• attract tobacco growers, customers or manufacturing and distribution partners;

• acquire complementary technologies, products or businesses;

• expand our operations in the United States or internationally;

• hire, train and retain employees; or

• respond to competitive pressures or unanticipated working capital requirements.

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We currently are not in compliance with annual “clean-up” provisions under a revolving line of credit.

Included in current liabilities at December 31, 2013 is a demand loan under a revolving credit agreement with a balance outstanding of $174,925, which is payable to a commercial bank and guaranteed by one of our shareholders. This exact same principal amount has been outstanding for over five years on a continuous basis, notwithstanding the fact that we have not complied with annual “clean-up” provisions which require that we repay all amounts outstanding for a period of 30 consecutive days each year. There are no additional amounts available to us under this credit agreement. We have paid interest only since 2008 (currently at the bank’s annual prime rate plus 0.75% or 4%) on a monthly basis according to the bank’s monthly payment statements. Our plans contemplate that this balance remains outstanding while we continue to pay interest only on a monthly basis. We may incur disruptions in our operations in the event the bank were to demand repayment in full, close the revolving credit agreement, and not allow us sufficient time to locate additional capital.

Our manufacturing facility is subject to FDA regulations.

Manufacturers of tobacco and pharmaceutical products must comply with FDA regulations which require, among other things, compliance with the FDA’s evolving regulations on Current Good Manufacturing Practices (“cGMP(s)”), which are enforced by the FDA through its facilities inspection program. The manufacture of products are subject to strict quality control, testing and record keeping requirements, and continuing obligations regarding the submission of safety reports and other post-market information. We cannot guarantee that our current manufacturing facility will pass FDA and/or similar inspections in foreign countries to produce our tobacco products or the final version of our X-22 smoking cessation aid, or that future changes to cGMP manufacturing standards will not also negatively affect the cost or sustainability of our manufacturing facility.

We will mainly depend on third parties to market, sell and distribute our products, and we currently have no commercial arrangements for the marketing, sale or distribution of our X-22 smoking cessation aid.

We expect to depend on third parties to a great extent to market, sell and distribute our products and we currently have no arrangements with third parties in place to provide such services for our X-22 smoking cessation aid. We cannot be sure that we will be able to enter into such arrangements on acceptable terms, or at all. If we are unable to enter into marketing, sales and distribution arrangements with third parties for our X-22 smoking cessation aid, we would need to incur significant sales, marketing and distribution expenses in connection with the commercialization of X-22 and any future potential products. We do not currently have a dedicated sales force, and we have no experience in the sales, marketing and distribution of pharmaceutical products. Developing a sales force is expensive and time-consuming, and we may not be able to develop this capacity. If we are unable to establish adequate sales, marketing and distribution capabilities, independently or with others, we may not be able to generate significant revenue and may not become profitable.

If our X-22 smoking cessation aid does not gain market acceptance among physicians, patients, third-party payers and the medical community, we may be unable to generate significant revenue.

Our X-22 smoking cessation aid may not achieve market acceptance among physicians, patients, third-party payers and others in the medical community. If we receive FDA approval for the marketing of X-22 as a smoking cessation aid in the U.S., the degree of market acceptance could depend upon a number of factors, including:

	•	limitations on the indications for use for which X-22 may be marketed;
	•	the establishment and demonstration in the medical community of the clinical efficacy and safety of our potential products and their potential advantages over existing products;
	•	the prevalence and severity of any side effects;
	•	the strength of marketing and distribution support; and
	•	sufficient third-party coverage or reimbursement.

The market may not accept our X-22 smoking cessation aid, based on any number of the above factors. Even if the FDA approves the marketing of X-22 as a smoking cessation aid, there are other FDA-approved products available and there will also be future competitive products which directly compete with X-22 . The market may prefer such existing or future competitive products for any number of reasons, including familiarity with or pricing of such products. The failure of any of our potential products to gain market acceptance could impair our ability to generate revenue, which could have a material adverse effect on our future business, financial condition, results of operations and cash flows.

Our principal competitors in the smoking cessation market have, and any future competitors may have, greater financial and marketing resources than we do, and they may therefore develop products or other technologies similar or superior to ours or otherwise compete more successfully than we do.

We have no experience in selling smoking cessation products. Competition in the smoking cessation aid products industry is intense, and we may not be able to successfully compete in the market. In the market for FDA-approved smoking cessation aids, our principal competitors include Pfizer Inc., GlaxoSmithKline PLC, Perrigo Company and Novartis International AG. The industry consists of major domestic and international companies, most of which have existing relationships in the markets which we plan to sell, as well as financial, technical, marketing, sales, manufacturing, scaling capacity, distribution and other resources and name recognition substantially greater than ours. In addition, we expect new competitors will enter the markets for our products in the future. Potential customers may choose to do business with our more established competitors, because of their perception that our competitors are more stable, are more likely to complete various projects, can scale operations more quickly, have greater manufacturing capacity, are more likely to continue as a going concern and lend greater credibility to any joint venture. If we are unable to compete successfully against manufacturers of other smoking cessation products, our business could suffer, and we could lose or be unable to obtain market share.

We face intense competition in the market for our RED SUN and MAGIC cigarettes and our BRAND A and BRAND B cigarettes, and our failure to compete effectively could have a material adverse effect on our profitability and results of operations.

Cigarette companies compete primarily on the basis of product quality, brand recognition, brand loyalty, taste, innovation, packaging, service, marketing, advertising, retail shelf space and price. We are subject to highly competitive conditions in all aspects of our business and we may not be able to effectively market and sell our RED SUN and MAGIC cigarettes or other cigarettes we may introduce to the market such as our BRAND A and BRAND B cigarettes as Modified Risk Cigarettes, upon FDA authorization. The competitive environment and our competitive position can be significantly influenced by weak economic conditions, erosion of consumer confidence, competitors’ introduction of low-price products or innovative products, higher cigarette taxes, higher absolute prices and larger gaps between price categories, and product regulation that diminishes the ability to differentiate tobacco products. Domestic competitors include Philip Morris USA Inc., Reynolds American Inc., Lorillard Inc., Commonwealth Brands, Inc., Liggett Group LLC, Vector Tobacco Inc. International competitors include Philip Morris International Inc., JT International SA, Imperial Tobacco Group PLC and regional and local tobacco companies; and in some instances, government-owned tobacco enterprises such as the China National Tobacco Corporation.

Our competitors may develop products that are less expensive, safer or more effective, which may diminish or eliminate the commercial success of any potential product that we may commercialize.

If our competitors market products that are less expensive, safer or more effective than our potential products, or that reach the market before our potential products, we may not achieve commercial success. The market may choose to continue utilizing existing products for any number of reasons, including familiarity with or pricing of these existing products. The failure of our X -22 smoking cessation aid or our cigarette brands to compete with products marketed by our competitors would impair our ability to generate revenue, which would have a material adverse effect on our future business, financial condition, results of operations and cash flows. Our competitors may:

• develop and market products that are less expensive or more effective than our products;

• commercialize competing products before we or our partners can launch our products; and

• initiate or withstand substantial price competition more successfully than we can.

If we fail to stay at the forefront of technological change, we may be unable to compete effectively.

Our competitors may render our technologies obsolete by advances in existing technological approaches or the development of new or different approaches, potentially eliminating the advantages that we believe we derive from our research approach and proprietary technologies. Our competitors may:

• operate larger research and development programs or have substantially greater financial resources than we do;

• have greater success in recruiting skilled technical and scientific workers from the limited pool of available talent;

• more effectively negotiate third-party licenses and strategic relationships; and

• take advantage of acquisition or other opportunities more readily than we can.

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Government mandated prices, production control programs, shifts in crops driven by economic conditions and adverse weather patterns may increase the cost or reduce the quality of the tobacco and other agricultural products used to manufacture our products.

We depend upon independent tobacco farmers to grow our specialty proprietary tobaccos with specific nicotine contents for our products. As with other agricultural commodities, the price of tobacco leaf can be influenced by imbalances in supply and demand, and crop quality can be influenced by variations in weather patterns, diseases and pests. We must also compete with other tobacco companies for contract production with independent tobacco farmers. Tobacco production in certain countries is subject to a variety of controls, including government mandated prices and production control programs. Changes in the patterns of demand for agricultural products could cause farmers to plant less tobacco. Any significant change in tobacco leaf prices, quality and quantity could affect our profitability and our business.

Our future success depends on our ability to retain key personnel.

Our success will depend to a significant extent on the continued services of our senior management team, and in particular Joseph Pandolfino, our Chief Executive Officer, Henry Sicignano III, our Chief Financial Officer and President, and Michael Moynihan, Ph.D., our Vice President of R&D. The loss or unavailability of any of these individuals may significantly delay or prevent the development of our potential products and other business objectives by diverting management’s attention to transition matters. While each of these individuals is party to employment agreements with us, they could terminate their relationships with us at any time, and we may be unable to enforce any applicable employment or non-compete agreements.

We also rely on consultants and advisors to assist us in formulating our research and development, manufacturing, distribution, marketing and sales strategies. All of our consultants and advisors are either self-employed or employed by other organizations, and they may have conflicts of interest or other commitments, such as consulting or advisory contracts with other organizations, that may affect their ability to contribute to us.

Product liability claims, product recalls or other claims could cause us to incur losses or damage our reputation.

The risk of product liability claims or product recalls, and associated adverse publicity, is inherent in the development, manufacturing, marketing and sale of tobacco and smoking cessation products. We do not currently have product liability insurance for our products or our potential products and do not expect to be able to obtain product liability insurance at reasonable commercial rates for these products. Any product recall or lawsuit seeking significant monetary damages may have a material adverse effect on our business and financial condition. A successful product liability claim against us could require us to pay a substantial monetary award. We cannot assure you that such claims will not be made in the future.

Risks Related to Regulatory Approvals and Insurance Reimbursement

If we fail to obtain FDA and foreign regulatory approvals of X-22 as a smoking cessation aid and FDA authorization to market BRAND A and BRAND B as Modified Risk Cigarettes, we will be unable to commercialize these potential products in and outside the U.S., other than the sale of our BRAND A and BRAND B cigarettes as conventional cigarettes.

There can be no assurance that our X-22 smoking cessation aid will be approved by the FDA, European Medicines Agency, or any other governmental body. In addition, there can be no assurance that all necessary approvals will be granted for our potential products or that review or actions will not involve delays caused by requests for additional information or testing that could adversely affect the time to market for and sale of our potential products. Our ability to complete the FDA-approval process in a timely manner is dependent, in part, on our ability to obtain “Fast Track” designation for X-22 by the FDA.

We submitted a request for Fast Track designation for X-22 , and on August 18, 2011, the FDA informed us that it would not grant the designation of X-22 as a Fast Track product at this time because we did not yet demonstrate that X-22 shows potential to address an unmet medical need. Except for our Phase II-B clinical trial, all smoking cessation studies with very low nicotine (“VLN”) cigarettes containing our proprietary tobacco were independent studies and were not sponsored by 22nd Century Ltd under its own Investigational New Drug (“IND”). We plan to reapply for Fast Track designation, but not until results of a clinical trial conducted by us demonstrates an advantage (over currently approved smoking cessation products) in one of the following areas: efficacy, safety or improvement in some other factor such as compliance (a patient using a product as directed) or convenience. There is no guarantee that the FDA will grant Fast Track designation to X-22 . We may also not obtain Priority Review of our X-22 New Drug Application (“NDA”), which would further delay FDA approval of X-22 . The length of the FDA’s review of a NDA without a Priority Review designation is normally ten months from the date of filing of the NDA, although it is possible in certain cases for such review time to be longer. However, the FDA’s goal for reviewing a product with Priority Review status is normally six months from the date of the filing of a NDA. If we do not obtain Priority Review of our New Drug Application, we would then expect the timing of FDA approval of X-22 to be extended several additional months. Even if X-22 is approved by the FDA, the FDA may require the product to only be prescribed to patients who have already failed to quit smoking with another approved therapy. Further, failure to comply with applicable regulatory requirements can, among other things, result in the suspension of regulatory approval as well as possible civil and criminal sanctions.

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The development, testing, manufacturing and marketing of our potential products are subject to extensive regulation by governmental authorities in the United States and throughout the world. In particular, the process of obtaining approvals by the FDA, European Medicines Agency and other international FDA equivalent agencies in targeted countries is costly and time consuming, and the time required for such approval is uncertain. Our X-22 smoking cessation aid must undergo rigorous clinical testing and an extensive regulatory approval process mandated by the FDA or EMEA. Such regulatory review includes the determination of manufacturing capability and product performance. Generally, only a small percentage of pharmaceutical products are ultimately approved for commercial sale.

The scope of review, including product testing and exposure studies, to be required by the FDA under the Tobacco Control Act in order for cigarettes such as BRAND A and BRAND B to be marketed as Modified Risk Cigarettes has not yet been fully established, even though the FDA issued Modified Risk Tobacco Product Applications Draft Guidance on March 30, 2012. We may be unsuccessful in establishing that BRAND A or BRAND B are Modified Risk Cigarettes, and we may fail to demonstrate that either BRAND A or BRAND B significantly reduces exposure to certain tobacco smoke toxins. Even upon demonstrating significant reduced exposure to certain tobacco smoke toxins, the FDA may decide that allowing a modified risk claim is not in the best interest of the public health, and the FDA may not allow us to market our BRAND A and/or BRAND B cigarettes as Modified Risk Cigarettes.

The FDA could force the removal of our products from the U.S. market.

The FDA could force us to remove from the U.S. market our tobacco products such as RED SUN or MAGIC since these are not grandfathered products under the Tobacco Control Act, and the FDA could force us to remove from the U.S. market BRAND A and/or BRAND B even after FDA authorization to market BRAND A and BRAND B as Modified Risk Cigarettes.

In the future, we intend to distribute and sell our potential products outside of the United States, which will subject us to other regulatory risks.

In addition to seeking approval from the FDA for our X-22 smoking cessation aid in the United States, we intend to seek governmental approvals required to market X-22 and our other potential products in other countries. Marketing of our X-22 smoking cessation aid is not permitted in certain countries until we have obtained required approvals or exemptions in the individual country. The regulatory review process varies from country to country, and approval by foreign governmental authorities is unpredictable, uncertain and generally expensive. Our ability to market our potential products could be substantially limited due to delays in receipt of, or failure to receive, the necessary approvals or clearances. We anticipate commencing the applications required in some or all of these countries following approval by the FDA; however, we may decide to file applications in advance of the FDA approval if we determine such filings to be both time and cost effective. If we export any of our potential products or products that have not yet been cleared for commercial distribution in the United States, such products may be subject to FDA export restrictions. Failure to obtain necessary regulatory approvals could impair our ability to generate revenue from international sources.

Market acceptance of our X-22 smoking cessation aid could be limited if users are unable to obtain adequate reimbursement from third-party payers.

Government health administration authorities, private health insurers and other organizations generally provide reimbursement for FDA-approved smoking cessation products, and our commercial success could depend in part on these third-party payers agreeing to reimburse patients for the costs of our X-22 smoking cessation aid. Even if we succeed in bringing our X-22 smoking cessation aid to market, there is no assurance that third-party payers will consider X-22 cost effective or provide reimbursement in whole or in part for its use.

Significant uncertainty exists as to the reimbursement status of newly approved health care products. Our X-22 smoking cessation aid is intended to replace or alter existing therapies or procedures. These third-party payers may conclude that our X-22 smoking cessation aid is less safe, effective or cost-effective than these existing therapies or procedures. Therefore, third-party payers may not approve X-22 for reimbursement.

If third-party payers do not approve X-22 or our potential products for reimbursement or fail to reimburse for them adequately, sales could suffer as some physicians or their patients could opt for a competing product that is approved for reimbursement or is adequately reimbursed. Even if third-party payers make reimbursement available, these payers’ reimbursement policies may adversely affect our ability and the ability of our potential collaborators to sell our potential products on a profitable basis.

The trend toward managed healthcare in the United States and, the Affordable Care Act enacted on March 23, 2010, and legislative proposals to reform healthcare and government insurance programs could significantly influence the purchase of healthcare services and products, resulting in lower prices and reduced demand for our potential products which could adversely affect our business, financial condition, results of operations and cash flows.

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In addition, legislation and regulations affecting the pricing of our potential products may change in ways adverse to us before or after the FDA or other regulatory agencies approve any of our potential products for marketing. While we cannot predict the likelihood of any of these legislative or regulatory proposals, if any government or regulatory agency adopts these proposals, they could materially adversely affect our business, financial condition, results of operations and cash flows.

Our clinical trials for any of our potential products may produce negative or inconclusive results and we may decide, or regulators may require us, to conduct additional clinical and/or preclinical testing for these potential products or cease our trials.

We do not know whether clinical trials of our potential products will demonstrate safety and efficacy sufficiently to result in marketable products. Because our clinical trials for our X-22 smoking cessation aid and any other potential products may produce negative or inconclusive results, we may decide, or regulators may require us, to conduct additional clinical and/or preclinical testing for these potential products or cease our clinical trials. If this occurs, we may not be able to obtain approval or marketing authorization for these potential products or our anticipated time of bringing these potential products to the market may be substantially delayed and we may also experience significant additional development costs. We may also be required to undertake additional clinical testing if we change or expand the indications for our potential products.

Risks Related to the Tobacco Industry

Our business faces significant governmental action aimed at increasing regulatory requirements with the goal of preventing the use of tobacco products.

Cigarette companies face significant governmental action, especially in the United States pursuant to the Tobacco Control Act, including efforts aimed at reducing the incidence of tobacco use, restricting marketing and advertising, imposing regulations on packaging, warnings and disclosure of flavors or other ingredients, prohibiting the sale of tobacco products with certain flavors or other characteristics, limiting or prohibiting the sale of tobacco products by certain retail establishments and the sale of tobacco products in certain packaging sizes, and seeking to hold retailers and distributors responsible for the adverse health effects associated with both smoking and exposure to environmental tobacco smoke. Governmental actions, combined with the diminishing social acceptance of smoking and private actions to restrict smoking, have resulted in reduced industry volume in the United States and certain other countries, and we expect that these factors will continue to reduce consumption levels in these countries.

Certain of such actions may have a favorable impact on our X-22 smoking cessation aid, or on our BRAND A and BRAND B cigarettes if we are able to market them as Modified Risk Cigarettes. However, there is no assurance of such favorable impact and such actions may have a negative impact on our ability to market RED SUN and MAGIC .

Significant regulatory developments will take place over the next few years in many markets, driven principally by the World Health Organization’s Framework Convention on Tobacco Control (“FCTC”). The FCTC is the first international public health treaty on tobacco, and its objective is to establish a global agenda for tobacco regulation with the purpose of reducing initiation of tobacco use and encouraging cessation. In addition, the FCTC has led to increased efforts by tobacco control advocates and public health organizations to reduce the appeal of tobacco products. Partly because of some or a combination of these efforts, unit sales of tobacco products in certain markets, principally Western Europe and Japan, have been in general decline and we expect this trend to continue. Our operating results could be significantly affected by any significant decrease in demand for cigarettes, any significant increase in the cost of complying with new regulatory requirements and requirements that lead to a commoditization of tobacco products such as the recent implementation of plain packaging in Australia.

If implemented in the future, the FDA requirement regarding graphic health warnings on cigarette packaging and in cigarette advertising is likely to have a negative impact on sales of our products.

In November 2010, as required by the Tobacco Control Act, the FDA issued a proposed rule to modify the required warnings that appear on cigarette packages and in cigarette advertisements. These warning were finalized on June 21, 2011 and consist of nine new textual warning statements accompanied by color graphics depicting the negative health consequences of smoking. The FDA selected nine images from the originally proposed 36 images after reviewing the relevant scientific literature, analyzing the results from an 18,000 person study and considering more than 1,700 comments from a variety of groups. The graphic health warnings were to be located beneath the cellophane wrapping on cigarette packages, and will comprise the top 50 percent of the front and rear panels of cigarette packages. The graphic health warnings will occupy 20 percent of a cigarette advertisement and will be located at the top of the advertisement. Each warning is accompanied by a smoking cessation phone number, 1-800-QUIT-NOW. Although these graphic health warnings were supposed to be implemented in September 2012, a federal judge ruled that these warnings are unconstitutional. If and when these graphic health warnings are implemented, all cigarettes manufactured for sale or distribution in the United States will need to include these new graphic health warnings on their packages. Any reduction in the number of smokers will probably reduce the demand for MAGIC and RED SUN , as well as X-22 , BRAND A and BRAND B , if and when implemented by the FDA. MAGIC , RED SUN , BRAND A and BRAND B will be subject to these new packaging and advertising regulations . It is unclear at this time whether the FDA may require X-22 and SPECTRUM to be subject to these new packaging and advertising regulations.

We may become subject to litigation related to cigarette smoking and exposure to environmental tobacco smoke, or ETS, which could severely impair our results of operations and liquidity.

Although we are not currently subject to legal proceedings, we may become subject to litigation related to the sale of our RED SUN and MAGIC cigarettes and, upon FDA authorization, our BRAND A and BRAND B cigarettes. Legal proceedings covering a wide range of matters related to tobacco use are pending or threatened in various U.S. and foreign jurisdictions. Various types of claims are raised in these proceedings, including product liability, consumer protection, antitrust, tax, contraband shipments, patent infringement, employment matters, claims for contribution and claims of competitors and distributors.

Litigation is subject to uncertainty and it is possible that there could be adverse developments in pending cases. An unfavorable outcome or settlement of pending tobacco related litigation could encourage the commencement of additional litigation. The variability in pleadings, together with the actual experience of management in litigating claims, demonstrates that the monetary relief that may be specified in a lawsuit bears little relevance to the ultimate outcome.

Damages claimed in some tobacco-related litigation are significant and, in certain cases range into the billions of dollars. We anticipate that new cases will continue to be filed. The FCTC encourages litigation against tobacco product manufacturers. It is possible that our results of operations, cash flows or financial position could be materially affected by an unfavorable outcome or settlement of litigation.

Cigarettes are subject to substantial taxes. Significant increases in cigarette-related taxes have been proposed or enacted and are likely to continue to be proposed or enacted in numerous jurisdictions. These tax increases may affect our sales and profitability and make us less competitive versus certain of our competitors.

Tax regimes, including excise taxes, sales taxes and import duties, can disproportionately affect the retail price of manufactured cigarettes versus other tobacco products, or disproportionately affect the relative retail price of our RED SUN and MAGIC cigarettes and, upon FDA authorization, our BRAND A and BRAND B cigarettes versus lower-priced cigarette brands manufactured by our competitors. Increases in cigarette taxes are expected to continue to have an adverse impact on sales of cigarettes resulting in (i) lower consumption levels, (ii) a shift in sales from manufactured cigarettes to other tobacco products or to lower-price cigarette categories, (iii) a shift from local sales to legal cross-border purchases of lower price products, and (iv) illicit products such as contraband and counterfeit.

We may become subject to governmental investigations on a range of matters.

Tobacco companies are often subject to investigations, including allegations of contraband shipments of cigarettes, allegations of unlawful pricing activities within certain markets, allegations of underpayment of custom duties and/or excise taxes, and allegations of false and misleading usage of descriptors such as “lights” and “ultra-lights.” We cannot predict the outcome of any to which we may become subject, and we may be materially affected by an unfavorable outcome of future investigations.

Risks Related to Intellectual Property

Our proprietary rights may not adequately protect our intellectual property, products and potential products, and if we cannot obtain adequate protection of our intellectual property, products and potential products, we may not be able to successfully market our products and potential products.

Our commercial success will depend in part on obtaining and maintaining intellectual property protection for our technologies, products and potential products. We will only be able to protect our technologies, products and potential products from unauthorized use by third parties to the extent that valid and enforceable patents cover them, or other market exclusionary rights apply.

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The patent positions of life sciences companies, like ours, can be highly uncertain and involve complex legal and factual questions for which important legal principles remain unresolved. No consistent policy regarding the breadth of claims allowed in such companies’ patents has emerged to date in the United States. The general patent environment outside the United States also involves significant uncertainty. Accordingly, we cannot predict the breadth of claims that may be allowed or that the scope of these patent rights could provide a sufficient degree of future protection that could permit us to gain or keep our competitive advantage with respect to these products and technology. Additionally, life science companies like ours are often dependent on creating a pipeline of products. We may not be able to develop additional potential products or proprietary technologies that produce commercially viable products or that are themselves patentable.

Although there are currently no challenges to any portion of our intellectual property, our issued patents may be subject to challenge and possibly invalidated by third parties. Changes in either the patent laws or in the interpretations of patent laws in the United States or other countries may diminish the value of our intellectual property. In addition, others may independently develop similar or alternative products and technologies that may be outside the scope of our intellectual property. Should third parties obtain patent rights to similar products or technology, this may have an adverse effect on our business.

We also rely on trade secrets to protect our technology, products and potential products, especially where we do not believe patent protection is appropriate or obtainable. Trade secrets, however, are difficult to protect. While we believe that we use reasonable efforts to protect our trade secrets, our own, our licensees’ or our strategic partners’ employees, consultants, contractors or advisors may unintentionally or willfully disclose our information to competitors. We seek to protect this information, in part, through the use of non-disclosure and confidentiality agreements with employees, consultants, advisors and others. These agreements may be breached, and we may not have adequate remedies for a breach. In addition, we cannot ensure that those agreements will provide adequate protection for our trade secrets, know-how or other proprietary information or prevent their unauthorized use or disclosure.

To the extent that consultants or key employees apply technological information independently developed by them or by others to our products and potential products, disputes may arise as to the proprietary rights of the information, which may not be resolved in our favor. Key employees are required to assign all intellectual property rights in their discoveries to us. However, these key employees may terminate their relationship with us, and we cannot preclude them indefinitely from dealing with our competitors. If our trade secrets become known to competitors with greater experience and financial resources, the competitors may copy or use our trade secrets and other proprietary information in the advancement of their products, methods or technologies. If we were to prosecute a claim that a third party had illegally obtained and was using our trade secrets, it could be expensive and time consuming and the outcome could be unpredictable. In addition, courts outside the United States are sometimes less willing to protect trade secrets than courts in the United States. Moreover, if our competitors independently develop equivalent knowledge, we would lack any contractual claim to this information, and our business could be harmed.

The ability to commercialize our potential products will depend on our ability to sell such products without infringing the patent or proprietary rights of third parties. If we are sued for infringing intellectual property rights of third parties, such litigation could be costly and time consuming and an unfavorable outcome could have a significant adverse effect on our business.

The ability to commercialize our potential products will depend on our ability to sell such products without infringing the patents or other proprietary rights of third parties. Third-party intellectual property rights in our field are complicated, and third-party intellectual property rights in these fields are continuously evolving. While we have conducted searches for such third-party intellectual property rights, we have not performed specific searches for third-party intellectual property rights that may raise freedom-to-operate issues, and we have not obtained legal opinions regarding commercialization of our potential products. As such, there may be existing patents that may affect our ability to commercialize our potential products.

In addition, because patent applications are published up to 18 months after their filing, and because patent applications can take several years to issue, there may be currently pending third-party patent applications and freedom-to-operate issues that are unknown to us, which may later result in issued patents.

If a third-party claims that we infringe on its patents or other proprietary rights, we could face a number of issues that could seriously harm our competitive position, including:

	•	infringement claims that, with or without merit, can be costly and time consuming to litigate, can delay the regulatory approval process and can divert management’s attention from our core business strategy;
	•	substantial damages for past infringement which we may have to pay if a court determines that our products or technologies infringe upon a competitor’s patent or other proprietary rights;

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	•	a court order prohibiting us from commercializing our potential products or technologies unless the holder licenses the patent or other proprietary rights to us, which such holder is not required to do;
	•	if a license is available from a holder, we may have to pay substantial royalties or grant cross licenses to our patents or other proprietary rights; and
	•	redesigning our process so that it does not infringe the third-party intellectual property, which may not be possible, or which may require substantial time and expense including delays in bringing our potential products to market.

Such actions could harm our competitive position and our ability to generate revenue and could result in increased costs.

Our patent applications may not result in issued patents, which may have a material adverse effect on our ability to prevent others from commercially exploiting products similar to ours.

We own 13 issued patents and we have the exclusive license to an additional 101 issued patents in an aggregate of 78 countries. In addition, we own or exclusively license 38 pending patent applications, of which we own 25 such patent applications and have an exclusive license to 13 such patent applications. We cannot assure you these patent applications will issue, in whole or in part, as patents. Patent applications in the United States are maintained in secrecy until the patents are published or are issued. Since publication of discoveries in the scientific or patent literature tends to lag behind actual discoveries by several months, we cannot be certain that we are the first creator of inventions covered by pending patent applications or the first to file patent applications on these inventions. We also cannot be certain that our pending patent applications will result in issued patents or that any of our issued patents will afford protection against a competitor. In addition, patent applications filed in foreign countries are subject to laws, rules and procedures that differ from those of the United States, and thus we cannot be certain that foreign patent applications related to U.S. patents will be issued. Furthermore, if these patent applications issue, some foreign countries provide significantly less effective patent enforcement than in the United States.

The status of patents involves complex legal and factual questions and the breadth of claims allowed is uncertain. Accordingly, we cannot be certain that the patent applications that we or our licensors file will result in patents being issued, or that our patents and any patents that may be issued to us in the near future will afford protection against competitors with similar technology. In addition, patents issued to us may be infringed upon or designed around by others and others may obtain patents that we need to license or design around, either of which would increase costs and may adversely affect our operations.

We license certain patent rights from third-party owners. If such owners do not properly maintain or enforce the patents underlying such licenses, our competitive position and business prospects could be harmed.

We license rights to third-party intellectual property that is necessary or useful for our business, and we may enter into additional licensing agreements in the future. Our success could depend in part on the ability of some of our licensors to obtain, maintain and enforce patent protection for their intellectual property, in particular, those patents to which we have secured exclusive rights. Our licensors may not successfully prosecute the patent applications to which we are licensed. Even if patents are issued with respect to these patent applications, our licensors may fail to maintain these patents, may determine not to pursue litigation against other companies that are infringing these patents, or may pursue such litigation less aggressively than we could. Without protection for the intellectual property we license, other companies might be able to offer substantially identical products for sale, which could adversely affect our competitive business position and harm our business prospects.

Our two worldwide exclusive licenses, one from North Carolina State University (“NCSU”) and the other from National Research Council of Canada, Plant Biotechnology Institute (“NRC”), each involve multiple patent families. The exclusive rights under the NCSU agreement expires on the date on which the last patent or registered plant variety covered by the subject license expires in the country or countries where such patents or registered plant varieties are in effect. The NCSU license relates predominately to issued patents, and our exclusive rights in the NCSU license will expire in 2023. The exclusive rights granted to us under the NRC agreement expire on the date on which the last patent covered by the subject license expires in the country or countries where such patents are in effect. The NRC license relates predominately to patent applications, and our exclusive rights in the NRC license will expire in 2028.

Risks Related to Ownership of Our Common Stock

An active trading market for our common stock may not develop or be sustained, and you may not be able to resell your shares at or above the price at which you purchased them.

An active trading market for our shares may not be sustained. In the absence of an active trading market for our common stock, shares of common stock may not be able to be resold at or above the purchase price of such shares. Although there can be no assurances, we expect that our common stock will continue to be quoted on the OTC Bulletin Board, an over-the-counter quotation system, on which the shares of our common stock are currently quoted. However, even if our common stock continues to be quoted on the OTC Bulletin Board, it is unlikely that an active market for our common stock will develop in the foreseeable future. It may be more difficult to dispose of shares or obtain accurate quotations as to the market value of our common stock compared to securities of companies whose shares are traded on the NASDAQ Stock Market or other stock exchanges.

Although we anticipate filing an application to list our common stock on a national securities exchange, such as NASDAQ or the New York Stock Exchange, there is no guarantee that we will be successful. Even if we are listed on a national securities exchange, there can be no assurance that we can maintain such listing. Accordingly, an active trading market may not be developed or sustained, and you may not be able to sell your shares at or above the price at which you purchased them.

Trading in our common stock is currently limited and our stock price may be highly volatile and could decline in value.

Our common stock is currently traded on the OTC Bulletin Board, and, therefore, the trading volume is currently more limited and sporadic than if our common stock were traded on a national stock exchange. Further, the market prices for securities in general have been highly volatile and may continue to be highly volatile in the future. The following factors, in addition to other risk factors described in this section, may have a significant impact on the market price of our common stock:

• results from and any delays in any clinical trials programs;

• failure or delays in entering potential products into clinical trials;

• failure or discontinuation of any of our research programs;

• delays in establishing new strategic relationships;

• delays in the development of our potential products and commercialization of our potential products;

• market conditions in our sector and issuance of new or changed securities analysts’ reports or

recommendations;

• general economic conditions, including recent adverse changes in the global financial markets;

• actual and anticipated fluctuations in our quarterly financial and operating results;

• developments or disputes concerning our intellectual property or other proprietary rights;

• introduction of technological innovations or new commercial products by us or our competitors;

• issues in manufacturing or distributing our products or potential products;

• market acceptance of our products or potential products;

• third-party healthcare reimbursement policies;

• FDA or other United States or foreign regulatory actions affecting us or our industry;

• litigation or public concern about the safety of our products or potential products;

• additions or departures of key personnel;

• third-party sales of large blocks of our common stock;

• sales of our common stock by our executive officers, directors or significant stockholders; and

• equity sales by us of our common stock or securities convertible into common stock to fund our operations.

These and other external factors may cause the market price and demand for our common stock to fluctuate substantially, which may limit or prevent investors from readily selling their shares of common stock and may otherwise negatively affect the liquidity of our common stock. In addition, in the past, when the market price of a stock has been volatile, holders of that stock have instituted securities class action litigation against the company that issued the stock. If any of our stockholders brought a lawsuit against us, we could incur substantial costs defending the lawsuit. Such a lawsuit could also divert the time and attention of our management.

Future sales of our common stock will result in dilution to our common stockholders.

Sales of a substantial number of shares of our common stock in the public market may depress the prevailing market price for our common stock and could impair our ability to raise capital through the future sale of our equity securities. Additionally, if the holders of outstanding options or warrants exercise or convert those shares, as applicable, our common stockholders will incur dilution in their relative percentage ownership. The prospect of this possible dilution may also impact the price of our common stock.

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Our common stock is a “penny stock,” which is likely to limit its liquidity.

The market price of our common stock is, and will likely remain for the foreseeable future, less than $5.00 per share, and therefore will be a “penny stock” according to SEC rules, unless our common stock is listed on a national securities exchange. The OTC Bulletin Board is not a national securities exchange. Designation as a “penny stock” requires any broker or dealer selling these securities to disclose certain information concerning the transaction, obtain a written agreement from the purchaser and determine that the purchaser is reasonably suitable to purchase the securities. These rules may restrict the ability of brokers or dealers to sell our common stock and may affect the ability of current holders of our common stock to sell their shares. Such rules may also deter broker-dealers from recommending or selling our common stock, which may further limit its liquidity. This may also make it more difficult for us to raise additional capital in the future. Because of such expected illiquidity, it will likely be difficult to re-sell shares of our common stock as desired.

We are controlled by our current officers and directors.

As of January 28, 2014, our directors and executive officers as a group beneficially owned approximately 27.8% of our common stock. Accordingly, our directors and executive officers will have substantial influence over, and may have the ability to control, the election of our board of directors and the outcome of issues submitted to a vote of our stockholders.

We do not expect to declare any dividends on our common stock in the foreseeable future.

We have not paid cash dividends to date on our common stock. We currently intend to retain our future earnings, if any, to fund the development and growth of our business, and we do not anticipate paying any cash dividends on our common stock for the foreseeable future. Additionally, the terms of any future debt facilities may preclude us from paying dividends on the common stock. As a result, capital appreciation, if any, of our common stock could be the sole source of gain for the foreseeable future.

Anti-takeover provisions contained in our articles of incorporation and bylaws, as well as provisions of Nevada law, could impair a takeover attempt.

Our amended and restated articles of incorporation and bylaws currently contain provisions that, together with Nevada law, could have the effect of rendering more difficult or discouraging an acquisition deemed undesirable by our board of directors. Our corporate governance documents presently include the following provisions:

• authorizing blank check preferred stock, which could be issued with voting, liquidation, dividend and other rights superior to our common stock; and

• limiting the liability of, and providing indemnification to, our directors and officers.

These provisions, alone or together, could delay hostile takeovers and changes in control of us or changes in our management.

As a Nevada corporation, we also may become subject to the provisions Nevada Revised Statutes Sections 78.378 through 78.3793, which prohibit an acquirer, under certain circumstances, from voting shares of a corporation’s stock after crossing specific threshold ownership percentages, unless the acquirer obtains the approval of the stockholders of the issuer corporation. The first such threshold is the acquisition of at least one-fifth, but less than one-third of the outstanding voting power of the issuer. We may become subject to the above referenced Statutes if we have 200 or more stockholders of record, at least 100 of whom are residents of the State of Nevada, and do business in the State of Nevada directly or through an affiliated corporation.

As a Nevada corporation, we are subject to the provisions of Nevada Revised Statutes Sections 78.411 through 78.444, which prohibit an “interested stockholder” from entering into a combination with the corporation, unless certain conditions are met. An “interested stockholder” is a person who, together with affiliates and associates, beneficially owns (or within the prior two years did own) 10 percent or more of the corporation’s voting stock.

Any provision of our amended and restated articles of incorporation, our bylaws or Nevada law that has the effect of delaying or deterring a change in control of our Company could limit the opportunity for our stockholders to receive a premium for their shares of our common stock, and could also affect the price that some investors are willing to pay for our common stock.

Item 1B

Unresolved Staff Comments.

None.

Item 2.

Properties.

Our principal administrative offices are located in Clarence, New York. We currently lease 3,800 square feet of office space. The lease commenced September 1, 2011 and expires August 31, 2014. Scheduled rent remaining as of December 31, 2013 is $28,000 for 2014. One January 25, 2013, the Company entered into a lease for manufacturing space in Depew, New York. The lease commenced on February 1, 2013 and expires July 31, 2015. Scheduled rent remaining as of December 31, 2013 is $17,316 for 2014 and $10,101 for 2015.

On October 9, 2013, we executed a guaranty that guarantees performance by NASCO Products, LLC (“NASCO”) of its obligations to the landlord under a certain triple net lease of the same date between NASCO and the landlord for warehouse and cigarette manufacturing facility located in North Carolina. Should the Purchase Agreement close, NASCO will become a wholly owned subsidiary of ours, making the lease our direct obligation. The lease commenced on January 14, 2014, and has an initial term of twelve (12) months (the “Initial Term”). The lease contains four (4) additional extensions; one for an additional one (1) year and three for an additional two (2) years in duration, exercisable at the option of NASCO. The lease also contains an early termination clause that provides NASCO with the right to terminate the lease at any time during the first nine (9) month of the Initial Term by giving ninety (90) days prior written notice to the landlord. Notwithstanding the above sentence, the lease calls for minimum lease payments of $96,000 during the Initial Term, $123,000 for the one (1) year optional extension, $144,525 and $153,750 for each year of the first two (2) year optional extensions, and $169,125 for each year of the final two (2) year optional extensions.

Item 3.

Legal Proceedings.

From time to time we may be involved in claims arising in the ordinary course of business. To our knowledge, no legal proceedings, governmental actions, investigations or claims are currently pending against us or involve us that, in the opinion of our management, could reasonably be expected to have a material adverse effect on our business and financial condition.

Item 4.

Mine Safety Disclosures

Not applicable

PART II

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Our common stock is quoted on the OTC Bulletin Board under the symbol “XXII.OB.” As of January 28, 2014, there were 89 holders of record of shares of our common stock. The following table sets forth, for the quarters indicated, the high and low bid prices per share of our common stock, as derived from quotations provided by the OTC Bulletin Board Information Center.

Quarter Ended	High Bid		Low Bid

December 31, 2013	$	2.19	$	0.87
September 30, 2013	$	1.74	$	0.70
June 30, 2013	$	0.90	$	0.46
March 31, 2013	$	1.07	$	0.51
December 31, 2012	$	0.95	$	0.15
September 30, 2012	$	0.88	$	0.20
June 30, 2012	$	1.13	$	0.35
March 31, 2012	$	0.75	$	0.25

Dividend Policy

We have not previously and do not plan to declare or pay any dividends on our common stock. Our current policy is to retain all funds and any earnings for use in the operation and expansion of our business. Payment of future dividends, if any, will be at the discretion of our board of directors after taking into account various factors, including current financial condition, operating results and current and anticipated cash needs.

Recent issuances of Unregistered Securities

Between October 3, 2013 and December 26, 2013, the Series A Warrant holder exercised on a cashless basis at $0.60 per share 3,678,889 Series A warrants resulting in the issuance of 1,972,976 shares of common stock of the Company, par value $0.00001 per share.

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On October 11, 2013, we issued 10,000 shares of its common stock, par value $0.00001 per share, to the keynote speaker at our annual shareholders’ meeting held on September 28, 2013.

On November 4, 2013, we issued 10,000 shares of its common stock, par value $0.00001 per share, pursuant to the terms of an agreement between us and IBIS Co. for investor relation services.

On December 12, 2013, we issued 5,504,369 shares of its common stock, par value $0.00001 per share, pursuant to the exercise of warrants. The exercise of warrants generated gross proceeds of $3,559,763.

On December 27, 2013, we issued an aggregate 55,000 shares of common stock pursuant to a contractor agreement with an effective date of October 30, 2012 between us and Angelo Tomasello.

On December 27, 2013, we issued 300,000 shares of common stock pursuant to an agreement dated November 14, 2013 between the us and Chardan Capital Markets, LLC for professional services.

The common stock offered and sold was pursuant to an exemption from the registration requirements under Sections 4 (2) of the Securities Act.

Shares authorized for issuance under equity compensation plans

October 21, 2010, the Company established the 2010 Equity Incentive Plan, or EIP, for officers, employees, directors, consultants and advisors to the Company and its affiliates, consisting of 4,250,000 shares of common stock. The EIP authorizes the grant of incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares, restricted stock and restricted stock units.

The following table summarizes the number of stock options issued and shares of restricted stock granted, net of forfeitures and sales, the weighted-average exercise price of such stock options and the number of securities remaining to be issued under all outstanding equity compensation plans as of December 31, 2013:

						Number of securities
						remaining available for
	Number of securities to			Weighted-average		issuance under equity
	be issued upon exercise			exercise price of		compensation plans
	of outstanding options,			outstanding options,		(excluding securities
	warrants and rights			warrants and rights		reflected in column (a))
	(a)		(b)			(c)

Equity compensation plans approved by security holders	1,160,000	(1)	$	0.74	(2)	850,000

Equity compensation plans not approved by security holders	0			N/A		0

Total	1,160,000					850,000

(1)

Includes 500,000 restricted stock awards that are issued but not vested as of December 31, 2013.

(2)

Weighted average exercise price only applies to the 660,000 shares issuable upon exercise of outstanding stock options.

Item 6.

Selected Financial Data.

This item is not applicable to us as a smaller reporting company.

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Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

This discussion should be read in conjunction with the other sections of this Report, including “Risk Factors,” and the Financial Statements. The various sections of this discussion contain a number of forward-looking statements, all of which are based on our current expectations and could be affected by the uncertainties and risk factors described throughout this Annual Report on Form 10-K. See “Forward-Looking Statements.” Our actual results may differ materially. For purposes of this Management’s Discussion and Analysis of Financial Condition and Results of Operations, references to the “Company,” “we,” us” or “our” refer to the operations of 22nd Century Group, Inc. and its direct and indirect subsidiaries for the periods described herein.

Recent Developments

Warrant Exchange Program

The primary purpose of the Warrant Exchange Program was to reduce 22nd Century Group’s “derivative warrant liability” through the exercise or amendment of the Company’s outstanding warrants in order for the Company to have sufficient stockholders’ equity to have its common stock listed on a national securities exchange – such as NASDAQ or NYSE. The Warrant Exchange Program was a success in achieving this goal since as of December 31, 2013, the Company had $7,522,888 of stockholders’ equity. The Company plans to file an application with either the NYSE or NASDAQ in early February to have its common stock listed on a national exchange. Prior to the Warrant Exchange Program, as of September 30, 2013, we had 19,616,308 warrants to purchase shares of common stock outstanding. These warrants contain “down round” provisions and anti-dilution features that provide for adjustments to the exercise price and number of warrants outstanding if we issued shares of common stock at a price that is less than the respective warrant exercise prices. These provisions require that these warrants be classified as derivatives for accounting purposes, which means they are reported as a liability and adjusted to fair value at each balance sheet date.

On November 14, 2013, we initiated a warrant exchange program (the “Warrant Exchange Program”) with the goal of reducing our warrant liability. The Company offered inducements for warrant holders to (1) exercise their warrant on a cash basis, (2) exercise their warrant on a cashless basis, or (3) agree to have the “down round provision” or anti-dilution feature removed from their warrant. The warrants holders also had the option to maintain the terms and conditions of their original warrant. Our executive officers and directors were prohibited from participating in the Warrant Exchange Program. As a result of the cash and cashless exercise of warrants, there is a reduced number of outstanding warrants, and as a result of the removal of the “down round” provisions and anti-dilution features on other warrants, these warrants are no longer required to be classified as a derivative liability. The Warrant Exchange Program closed on December 12, 2013, generated gross proceeds of $3,559,763, and resulted in the issuance of 5,348,172 shares of our common stock from the cash exercise of warrants. The issuance of an additional 156,197 shares of our common stock resulted from the exercise of 513,949 warrants that were exercised on a cashless basis. As an inducement for warrant holders to agree to remove their “down round” provisions and anti-dilution features from their warrant, 138,666 additional warrants were issued.

As a result of the Warrant Exchange Program, there were 6,732,088 warrants outstanding at December 31, 2013 that do not contain the “down round” provisions or anti-dilution features. We calculated the cost of inducement as the difference between the fair value of the warrants immediately after the Warrant Exchange Program was closed on December 12, 2013, less the fair value of the warrants immediately prior to Warrant Exchange Program completion. We estimated the total cost of inducement to be $3,736,313, and this expense has been recorded as an “Other Expense” on the consolidated statements of operations and as an increase to the derivative warrant liability, and subsequently reversed into capital. We paid $320,378 and issued 300,000 shares of common stock to Chardan Capital Markets, LLC in conjunction with the Warrant Exchange Program. The fair value of the 300,000 shares issued to Chardan in the amount of $462,000 is included as a component of the total cost of inducement.

BAT License

On October 1, 2013, 22nd Century Ltd entered into a Research License and Commercial Option Agreement (the “BAT Research Agreement”) with British American Tobacco (Investments) Limited (“BAT”), a subsidiary of British American Tobacco plc.

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If BAT exercises the option for a worldwide Commercial License, BAT is required to pay 22nd Century Ltd $3.0 million in aggregate annual license fees over a two-year ramp-up period, and thereafter, a royalty of (i) $100 per metric ton of licensed tobacco that is supplied to, or grown and ready for shipment to, BAT and is affiliates (other than Reynolds American, Inc. and Reynolds’ affiliates) and all other third parties; and (ii) $200 per metric ton of licensed tobacco supplied to, or grown and processed by, BAT’s affiliate Reynolds American, Inc.

The minimum and maximum amount of annual royalties under the terms of the Commercial License, which commence after the two-year ramp-up period from the exercise of the option, are $3.0 million and $15.0 million, respectively for a period of three years. Thereafter, the minimum and maximum annual royalties increase to $5.0 million and $25.0 million, respectively, until September 28, 2028. Thereafter, no further minimum royalties are due and the maximum annual royalties due remain at $25.0 million until expiration of the Commercial License.

British American Tobacco sells products in approximately 180 countries. In 2012, global production of tobacco leaf was approximately 5,700,000 metric tons, of which BAT utilized approximately 10% for BAT’s and its affiliates’ brands.

NASCO Acquisition

On September 17, 2013, we entered into a Membership Interest Purchase Agreement (“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”), for consideration of $1,000,000, consisting of a cash payment of $200,000 and the issuance of $800,000 in value of unregistered shares of our common stock. 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 from NAAG and certain attorneys general of the settling states of the MSA. NAAG has been discussing the NASCO Transaction with a small working group of settling states of the MSA for which the Company has answered various rounds of questions. The working group has presented the matter to all the settling states with a recommended course of action which the settling states are evaluating. Upon the entry of a revised adherence agreement of NASCO Products, LLC reflecting the NASCO Transaction, we believe we will be able to close the NASCO Transaction. The NASCO Transaction contains termination rights, including a right for us to terminate the Purchase Agreement, at our sole discretion, if the closing shall not have occurred on or before January 31, 2014. At this time we do not expect to invoke our termination rights.

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Business Overview

22nd Century Ltd, our wholly-owned subsidiary, is a plant biotechnology company focused on tobacco harm reduction and smoking cessation products produced from modifying the nicotine content in tobacco plants through genetic engineering and plant breeding. We exclusively control 114 issued patents and an additional 38 patent applications; of these, we own 13 issued patents plus 25 patent applications and we license the remaining patents and patent applications on an exclusive basis. Goodrich and Hercules Pharmaceuticals are subsidiaries of 22nd Century Ltd. Goodrich Tobacco is focused on commercial tobacco products and potentially reduced-risk or modified risk tobacco products. Hercules Pharmaceuticals is focused on X-22, a prescription smoking cessation aid in development.

The tobacco industry is at the beginning of a paradigm shift towards the development and commercialization of reduced-risk tobacco products which represent a significant step toward achieving the public health objective of harm reduction. The Company’s 15 years of research and development on the tobacco plant, mainly on the nicotine biosynthetic pathway, uniquely positions us to become a major benefactor of this paradigm shift developing in the tobacco industry. Our technology has created, and will continue to develop, a pipeline of products. The Company is primarily involved in the following activities:

⋅

The international licensing of 22nd Century Ltd’s technology, proprietary tobaccos, trademarks;

⋅

The manufacture, marketing and international distribution of RED SUN and MAGIC proprietary cigarettes;

⋅

The production of SPECTRUM research cigarettes for the National Institute on Drug Abuse (“NIDA”);

⋅

The research and development of potentially reduced-risk or modified risk tobacco products;

⋅

The development of X-22 , a prescription-based smoking cessation aid consisting of very low nicotine (“VLN”) cigarettes; and

⋅

The pursuit of necessary regulatory approvals and clearances from the FDA to market in the U.S. X-22 as a prescription smoking cessation aid and BRAND A and BRAND B as reduced-risk or Modified Risk Cigarettes.

We believe our proprietary technology, tobaccos and products will generate multiple significant revenue streams from licensing of our technology and tobacco and from the sales of our products.

Please refer to the “Business” section in this Annual Report on Form 10-K for additional information regarding our business and operations.

Results of Operations

Year Ended December 31, 2013 Compared to Year Ended December 31, 2012

Revenue - Royalties from licensing. In the year ended December 31, 2013, we realized royalty revenue of $7.0 million from the worldwide Research License and Commercial Option Agreement entered into with BAT. There was no licensing revenue for the year ended December 31, 2012.

Revenue - Sale of products. In the year ended December 31, 2013, we recognized revenue from the sale of products in the amount of $278,383. This revenue was derived from the sale of our proprietary VLN tobacco to a customer in the Netherlands in the amount of $52,500 and from the sale of our VLN tobacco to the FDA as a subcontractor under a government contract between RTI and the FDA in the amount of $225,883. In the year ended December 31, 2012, we realized revenue of $18,775, mainly from our research cigarette program.

Costs of goods sold - Royalties for licensing . In the year ended December 31, 2013, we recorded a royalty expense for licensing in the amount of $413,566. A portion of the patented technology sublicensed to BAT, as described above, 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. There was no royalty expense for licensing for the year ended December 31, 2012.

Costs of goods sold - Products . In the year ended December 31, 2013, costs of goods sold were $48,105 or 17% of revenue. In the year ended December 31, 2012, the cost of goods sold were $67,967 and exceeded revenue by 362% since we provided RTI with certain SPECTRUM research cigarettes without charge mainly due to production delays.

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Research and development expense . Research and development expense was $744,230 in the year ended December 31, 2013, an increase of $15,005, or 2.1%, from $729,225 in the year ended December 31, 2012. This increase is primarily the result of an increase in research and development costs and payroll costs in the amount of $49,802 and $34,360, respectively, partially offset by a decrease in royalty fees and equity based compensation of $35,391 and $33,512, respectively.

General and administrative expense . General and administrative expense was $4,106,694 in the year ended December 31, 2013, an increase of $1,901,244, or 86.2%, from $2,205,450 in the year ended December 31, 2012. The increase was primarily attributable to increases in third-party investor relation services, both cash and equity based, of $1,101,675, equity based employee compensation of $224,049, administrative payroll costs of $238,236, and professional fees of $241,790, for the year ended December 31, 2013, as compared to the year ended December 31, 2012. The increase in administrative payroll costs is the result of hiring a full time CFO, increases in employees’ salaries, and bonus to an executive officer. The increase in professional fees is mainly the result of legal fees for services provided in conjunction with the BAT Research License and Commercial Option Agreement and the NASCO Membership Interest Purchase Agreement.

Sales and marketing costs . Sales and marketing costs were $9,052 in the year ended December 31, 2013, a decrease of $52,824, or 85.4%, from $61,876 in the year ended December 31, 2012. Some minor promotional costs were incurred during the year ended December 31, 2013, but we do not intend to incur any significant sales and marketing costs until the national distribution of our products in the U.S.

Amortization and depreciation expense. Amortization and depreciation expense relates almost entirely to capitalized patent and trademark costs. Amortization and depreciation expense decreased 27.3% in the year ended December 31, 2013 to $144,289 from $198,406 in the year ended December 31, 2012. This net decrease of $54,117 is mainly due to a change in an accounting estimate pertaining to the estimated useful life of certain patent families resulting in an increase in the amortization period. This decrease was partially offset by our amortization of additional investment in patents and trademarks in 2013 of $332,826 and in 2012 of $162,774.

Warrant liability loss - net . In a private placement in the first quarter of 2013, we issued warrants which were accounted for as derivatives and upon issuance a liability at the estimated fair value was recorded. At the date of issuance of these warrants, the value exceeded that total consideration received by an aggregate of $3,987,655 resulting in an immediate charge to expense for this amount. In connection with the exercise of 1,101,034 Series B Warrants in July 2013, we issued a like number of Series C Warrants which were accounted for as derivatives and upon issuance a liability at the estimated fair value was recorded. At the date of issuance of these warrants, the value was estimated to be $1,622,069, which exceeded the sum of the net proceeds received in the exercise and the reclassification of warrant liability to capital by $343,079 resulting in an immediate charge to expense for this amount. These two charges added to the loss on warrant liability of $19,271,977, resulting from an increase in the fair value during the year ended December 31, 2013 for all warrants we have issued, resulting in a total loss on warrant liability for the year of $23,602,711. The loss on warrant liability from the change in fair value of $19,271,977 was primarily the result of an increase in the Company’s underlying stock price from $0.75 per share at December 31, 2012, as compared to $2.14 per share at December 31, 2013.

In connection with the May 2012 private placement, we issued warrants which were accounted for as derivatives and upon issuance a liability at the estimated fair value was recorded. At the date of issuance of these warrants, the value 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 expense for this amount. This charge was in addition to the loss of $1,183,543 resulting from the increase in the estimated fair value during the year ended December 31, 2012 of all warrants we have issued. The loss on warrant liability of $1,183,543 was primarily the result of an increase in the Company’s underlying stock price from $0.42 per share at December 31, 2011 as compared to $0.75 per share at December 31, 2012.

Future periods will reflect a gain or loss based on the change in the fair value of the derivatives, which is based on a number of factors including the Company’s stock price.

Interest expense and amortization of debt discount and expense . Interest expense and amortization of debt discount and debt issuance costs decreased in the year ended December 31, 2013 to $748,605 from $1,494,545 in the year ended December 31, 2012. This decrease of $745,940 or 49.9% was primarily a result of a decrease of $1,298,982 in the amortization of debt discount and debt issuance costs. The decrease in the amortization of debt discount and debt issuance costs relates primarily to the Convertible Notes issued on December 14, 2011, which were fully amortized in December 2012. Offsetting the decrease in amortization of debt discounts and debt issuance costs were the fair value of warrants issued in excess of related debt converted to common stock during 2013 in the amount of $526,448, which is treated as a direct charge to interest expense.

Operating income (loss) and Net loss . We had operating income of $1,812,447 in the year ended December 31, 2013, as compared to an operating loss of $3,244,149 in the year ended December 31, 2012. This increase in operating income of $5,056,596 is primarily the result of $7,000,000 in royalty revenue received from BAT under the Research License and Commercial Option Agreement. We had a net loss in the year ended December 31, 2013 in the amount of $26,153,158, as compared to a net loss of $6,736,737 in the year ended December 31, 2012. The increased loss is primarily due to the increase in the warrant liability loss – net and inducement costs related the Warrant Exchange Program, partially offset by the royalty revenue received from BAT.

Liquidity and Capital Resources

Working Capital

As of December 31, 2013, we had positive working capital of approximately $6.8 million, as compared to negative working capital of approximately $3.3 million at December 31, 2012. The $10.1 million increase in working capital was primarily the result of net proceeds realized through a series of equity transactions in the amount of $7.5 million and the completion of a worldwide Research License and Commercial Option Agreement with BAT that generated gross revenues of $7.0 million.

Cash demands on operations

In 2013, we had operating income of approximately $1.8 million and generated cash from operations of approximately $3.9 million during the year ended December 31, 2013. Excluding contract growing of our proprietary tobacco with farmers, extraordinary expenses such as potential clinical trials and additional factory start-up costs, our monthly cash expenditures are approximately $200,000. We believe that cash on hand at December 31, 2013 of $5,830,599 is adequate to sustain operations and meet all current obligations as they come due for a period in excess of 12 months.

Net Cash provided by (used in) Operating Activities

In the year ended December 31, 2013, $3,855,834 of cash was provided by operating activities compared to $1,764,445 of cash used in operating activities in the year ended December 31, 2012. This increase in cash provided by operations of $5,620,279 was mainly due to the license revenue received from BAT under the Research License and Commercial Option Agreement in the amount of $7,000,000 in 2013 as compared to minimal revenue received in 2012.

Net Cash used in Investing Activities

In the year ended December 31, 2013, we used $3,742,789 of cash related to the acquisition of third party patents and trademarks and the acquisition of various cigarette manufacturing equipment, a portion of which will be held for resale, as compared to $162,774 used in the year ended December 31, 2012. The increase is mainly attributable to the acquisition of various cigarette manufacturing equipment acquired in North Carolina out of bankruptcy that will be used in our cigarette manufacturing business.

Net cash from Financing Activities

During the year ended December 31, 2013, we generated $5,717,366 from our financing activities mainly as a result of net cash proceeds received from the Series A-1 Preferred stock in the amount of $2,034,664, net cash proceeds received from the exercise of warrants in the amount of $2,254,999, proceeds received from the issuance of notes payable in the amount of $150,000, proceeds received from the exercise of stock options in the amount of $5,200, and net cash proceeds received from the Warrant Exchange Program in the amount of $3,239,385. These proceeds raised were partially offset by payments on notes payable, convertible notes payable and net payments to related parties and officers in the amount of $1,620,299, $339,250 and $8,993, respectively. During the year ended December 31, 2012, we generated $1,675,158 from our financing activities mainly as a result of the $1,467,500 proceeds from the May and November 2012 private placements, the $210,000 proceeds from the August 9, 2012 convertible notes, $4,136 in advances from officers and $56,000 in proceeds from the issuance of short term secured notes, partially offset by payments on borrowings of $41,000 and net payments to a related party of $21,478.

Critical Accounting Policies and Estimates

Accounting principles generally accepted in the United States of America, or U.S. GAAP, require estimates and assumptions to be made that affect the reported amounts in our consolidated financial statements and accompanying notes. Some of these estimates require difficult, subjective and/or complex judgments about matters that are inherently uncertain and, as a result, actual results could differ from those estimates. Due to the estimation processes involved, the following summarized accounting policies and their application are considered to be critical to understanding our business operations, financial condition and results of operations.

Revenue Recognition

We recognize revenue at the point the product is shipped to a customer and title has transferred. Revenue from the sale of our products is recognized net of cash discounts, sales returns and allowances. Federal cigarette excise taxes are included in net sales and accounts receivable billed to customers, except on sales of SPECTRUM and exported cigarettes in which such taxes do not apply.

We were chosen to be a subcontractor for a government contract between RTI International (“RTI”) and the National Institute on Drug Abuse (“NIDA”) to supply NIDA research cigarettes. These government research cigarettes are distributed under the Company’s mark SPECTRUM . Goodrich Tobacco has thus far delivered approximately 12 million SPECTRUM research cigarettes during the year ended December 31, 2012 and 2011 and recognized the related revenue of approximately $807,000. There were no SPECTRUM cigarettes delivered during the year ended December 31, 2013. Future revenue under this arrangement is expected to be related to the delivery of SPECTRUM and will be recognized at the point the product is shipped and title has transferred. In September 2013, we received a purchase order for an additional 5.5 million SPECTRUM research cigarettes that will be manufactured and shipped in January 2014. Total revenue from this order will be approximately $448,000 and a down payment on the order was received in the fourth quarter of 2013 in the amount of $179,014. The down payment has been recorded as deferred revenue on the Company’s balance sheet at December 31, 2013.

As described above, we license our patented technology to third parties. Revenue is recognized from licensing arrangements as contractually defined in licensing agreements. We account for milestone elements contained in licensing agreements in accordance with ASC 605. Simultaneous with the signing of the Research License and Commercial Option Agreement, BAT paid us a non-refundable $7,000,000. Revenue was recognized for this amount since delivery of the patented technology took place, we had no further performance obligations, and the fee was fixed. We will be entitled to receive additional payments from BAT, up to an additional $7,000,000, during the Research Term in the event certain milestones are met by BAT with respect to BAT’s research and development of our patent rights licensed by the Company to BAT. There are four separate milestones, two of which BAT would pay 22nd Century Ltd $2 million for each milestone achieved, and two of which BAT would pay 22nd Century Ltd $1.5 million for each milestone achieved. In addition, the Company could earn additional future royalties if BAT elects to exercise the Commercial Option Agreement during the Research Term.

No amount related to the research milestones was recognized during 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 agreement of 22nd Century Ltd and the third party licensor.

Impairment of Long-Lived Assets

We review the carrying value of amortizing long-lived assets whenever events or changes in circumstances indicate that the historical cost-carrying value of an asset may no longer be appropriate. We also assess recoverability of the asset by estimating the future undiscounted net cash flows expected to result from the asset, including eventual disposition. If the estimated future undiscounted net cash flows are less than the carrying value of the asset, an impairment loss is recorded equal to the difference between the asset’s carrying value and its fair value. Non-amortizing intangibles (e.g., patents and trademarks) are reviewed annually for impairment. We have not recognized any impairment losses during the two year period ended December 31, 2013.

Amortization Estimates of Intangible Assets

We generally determine amortization based on the estimated useful lives of the assets and record amortization expense on a straight-line method over such lives. The remaining life of the primary patent in each patent family is generally used to determine the estimated useful life of the related patent costs.

Valuation of our Equity Securities

We use a fair-value based method to determine compensation for all arrangements under which Company employees and others receive shares, options or warrants to purchase common shares of 22nd Century Group. Stock based compensation expense is recorded over the requisite service period based on estimates of probability and time of achieving milestones and vesting. For accounting purposes, the shares will be considered issued and outstanding upon vesting.

Convertible Debt

When the convertible feature of the conventional convertible debt is issued, the embedded conversion feature is evaluated to determine if bifurcation and derivative treatment is required whether there is a beneficial conversion feature. When the convertible debt provides for an effective rate of conversion that is below market value, this feature is characterized as a beneficial conversion feature (“BCF"). Prior to the determination of the BCF, the proceeds from the debt instrument were first allocated between the convertible debt and any embedded or detachable free standing instruments that are included, such as common stock and warrants. We record a BCF as a debt discount pursuant to FASB ASC Topic 470-20. In those circumstances, the convertible debt will be recorded net of the discount related to the BCF. We amortize the discount to interest expense over the life of the debt.

For the convertible notes issued December 2011 and August 2012, we recorded the OID and the BCF related to these convertible notes as a debt discount and recorded the convertible notes net of the discount related to both the OID and the BCF. Debt discount is amortized to interest expense over the life of the debt.

Income taxes

The Company recognizes deferred tax assets and liabilities for any basis differences in its assets and liabilities between tax and GAAP reporting, and for operating loss and credit carry-forwards. In light of the Company’s history of cumulative net operating losses and the uncertainty of their future utilization, the Company has established a valuation allowance to fully offset its net deferred tax assets as of December 31, 2013 and 2012.

Derivative Financial Instruments

We do not use derivative instruments to hedge exposures to cash flow, market or foreign currency risks. We evaluate all of our financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair market value and then is revalued at each reporting date, with changes in fair value reported in the consolidated statement of operations. The methodology for valuing our outstanding warrants classified as derivative instruments utilizes a lattice model approach which includes probability weighted estimates of future events including volatility of our common stock. A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement. The warrant liability is measured at fair value using certain estimated factors such as volatility and probability which are classified within Level 3 of the valuation hierarchy. Significant unobservable inputs are used in the fair value measurement of the Company’s derivative warrant liabilities include volatility. Significant increases (decreases) in the volatility input would result in a significantly higher (lower) fair value measurement. A 10% increase or decrease in the volatility factor used as of December 31, 2013 would have the impact of increasing or decreasing the liability by approximately $450,000.

The classification of derivative instruments, including whether such instruments should be recorded as liabilities or equity, is evaluated at the end of each reporting period. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument could be required within twelve months of the balance sheet date.

Inflation

Inflation did not have a material effect on our operating results for the years ended December 31, 2013 and 2012.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements as defined by Item 303(a)(4) of Regulation S-K.

Item 7A.

Quantitative and Qualitative Disclosures about Market Risk.

As a smaller reporting company, we are not required to present the information required by this item.

Item 8.

Financial Statements and Supplementary Data.

The required financial statements and the notes thereto are contained in a separate section of this Form 10-K Information section beginning with the page following Item 15 (Exhibits and Financial Statement Schedules).

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None

	41

Item 9A.

Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in its Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including the Company’s chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Our chief executive officer and chief financial officer, after evaluating the effectiveness of the Company’s “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 (Exchange Act) Rules 13a-15(e) or 15d-15(e)) as of the end of the period covered by this annual report, has concluded that our disclosure controls and procedures were not effective and that material weaknesses described below exists in our internal control over financial reporting based on his evaluation of these controls and procedures as required by paragraph (b) of Exchange Act Rules 13a-15 or 15d-15.

Management’s Annual Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed by, or under the supervision of, the chief executive officer also acting as chief financial officer and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

Our evaluation of internal control over financial reporting includes using the COSO framework, an integrated framework for the evaluation of internal controls issued by the Committee of Sponsoring Organizations of the Treadway Commission in 1992, to identify the risks and control objectives related to the evaluation of our control environment.

Based on our evaluation under the frameworks described above, our management concluded that as of December 31, 2013, that our internal controls over financial reporting were not effective and that material weaknesses exist in our internal control over financial reporting. The material weakness consists of controls associated with segregation of duties and controls associated with accounting for complex and non-routine transactions relating to certain equity and derivative instruments. To address the material weakness we performed additional analyses and other post-closing procedures to ensure that our consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). Notwithstanding this material weakness, management believes that the financial statements included in this Annual Report on Form 10-K fairly present, in all material respects, our financial condition, result of operations and cash flows for the periods presented.

This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation requirements by the Company’s registered public accounting firm pursuant to an exemption provided by the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Changes in Internal Control over Financial Reporting

There was no change in the Company’s internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) during the quarter ended December 31, 2013 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Item 9B.

Other Information.

On January 28, 2014, our board of directors approved and adopted amended and restated bylaws. The following description of the sections of the amended and restated bylaws that differ from our prior bylaws is only a summary and is qualified by reference to the amended and restated bylaws, which are filed as part of this Annual Report on Form 10-K.

	42

Meetings of Stockholders . The amended and restated bylaws provide that, for matters to be properly brought before an annual meeting, business must be either (i) specified in the notice of annual meeting (or any supplement or amendment thereto) given by or at the direction of the board of directors, (ii) otherwise brought before the annual meeting by or at the direction of the board of directors, or (iii) otherwise properly brought before the annual meeting by a stockholder. In addition to any other applicable requirements, for business to be properly brought before an annual meeting by a stockholder, the stockholder must have given timely notice thereof in writing to our secretary. To be timely, a stockholder’s notice must be delivered to the secretary at our principal executive offices not later than the close of business on the ninetieth (90th) day nor earlier than the close of business on the one hundred twentieth (120th) day prior to the first anniversary of the preceding year’s annual meeting; provided, however, that in the event that the date of the annual meeting is more than thirty (30) days before or more than seventy (70) days after such anniversary date, notice by the stockholder must be so delivered not earlier than the close of business on the one hundred twentieth (120th) day prior to such annual meeting and not later than the close of business on the later of the ninetieth (90th) day prior to such annual meeting or the tenth (10th) day following the day on which public announcement of the date of such meeting is first made by us.

Quorum . The holders of one-third (33.33%) of the voting power of our stock at any meeting of stockholders, which are present in person or represented by proxy, shall constitute a quorum for the transaction of business except as otherwise provided by law, by the articles of incorporation, or by the bylaws.

Voting. When a quorum is present at any meeting, action of the stockholders on a matter other than the election of directors is approved if the number of votes cast in favor of the action exceeds the number of votes cast in opposition to the action, unless the question is one upon which by express provision of the statutes, or the articles of incorporation, or the bylaws, a different vote is required in which case such express provision shall govern and control the decision of such question. Directors shall be elected by a plurality of the votes cast by the stockholders.

Special Meetings. Special meetings of the stockholders, for any purpose or purposes, unless otherwise prescribed by statute or by the articles of incorporation, may be called by the Chief Executive Officer and shall be called by the Chief Executive Officer or the Secretary at the request in writing of a majority of the board of directors or by the holders of a majority of the shares of voting stock.

Action by Stockholders . Stockholders may only take action at an annual or special meeting of stockholders. Stockholders may not take action by written consent without a meeting.

Nominations of Directors . Nominations of persons for election to the board at the annual meeting may be made at such meeting by or at the direction of the board, by any committee or persons appointed by the board or by any stockholder entitled to vote for the election of directors at the meeting who complies with the notice procedures set forth in the bylaws. Such nominations by any stockholder shall be made pursuant to timely notice in writing to the Secretary. To be timely, a stockholder’s notice shall be delivered to the Secretary at our principal executive offices not later than the close of business on the ninetieth (90th) day nor earlier than the close of business on the one hundred twentieth (120th) day prior to the first anniversary of the preceding year’s annual meeting; provided, however, that in the event that the date of the annual meeting is more than thirty (30) days before or more than seventy (70) days after such anniversary date, notice by the stockholder must be so delivered not earlier than the close of business on the one hundred twentieth (120th) day prior to such annual meeting and not later than the close of business on the later of the ninetieth (90th) day prior to such annual meeting or the tenth (10th) day following the day on which public announcement of the date of such meeting is first made.

PART III

Item 10.

Directors, Executive Officers and Corporate Governance.

Information concerning our executive officers, directors and corporate governance is incorporated herein by reference to our definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Form 10-K with respect to its 2014 Annual Meeting of Stockholders.

Set forth below is information regarding our directors, executive officers and key personnel.

Name	Age	Position
Joseph Pandolfino	45	Chief Executive Officer and Director
Henry Sicignano, III	46	President, Secretary and Director
John T. Brodfuehrer	56	Chief Financial Officer and Treasurer
Michael R. Moynihan, Ph.D.	61	Vice President of R&D
Joseph Alexander Dunn, Ph.D.	60	Director*
James W. Cornell	57	Director**
Richard M. Sanders	60	Director***

	43

* Dr. Dunn is currently Associate Dean for Research and Professor of Pharmaceutical Sciences at D’Youville College of Pharmacy in Buffalo, New York and has served in this capacity since April 1, 2010.

** Mr. Cornell is currently the President and Chief Executive Officer of Praxiis, LLC, an enterprise that provides support for clients in organizational change, leadership development and transactional advisory services. Mr. Cornell is also the current Manager of Larkin Center Management, LLC, a real estate development company, and has served in this capacity since October 2010.

*** Since August 2009, Mr. Sanders has served as a General Partner of Phase One Ventures, LLC, a venture capital firm which focuses on nanotechnology and biotechnology start-up opportunities in New Mexico and surrounding states.

Code of Ethics

In 2006, we adopted a Code of Ethics that applies to all of our employees. A copy of our Code of Ethics is available on our website at xxiicentury.com and will be provided to any person requesting same without charge. To request a copy of our Code of Ethics, please make a written request to our Chief Executive Officer c/o 22nd Century Group, Inc., 9530 Main Street, Clarence, New York 14031. Future material amendments or waivers relating to the Code of Ethics will be disclosed on our website referenced in this paragraph within four business days following the date of such amendment or waiver.

Item 11.

Executive Compensation.

Information is incorporated herein by reference to our definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Form 10-K with respect to its 2014 Annual Meeting of Stockholders .

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

Item 13.

Certain Relationships and Related Transactions, and Director Independence.

Item 14.

Principal Accounting Fees and Services.

PART IV

Item 15.

Exhibits and Financial Statement Schedules.

(a)

Financial Statements

	44

22nd CENTURY GROUP, INC. AND SUBSIDIARY

INDEX TO FINANCIAL STATEMENTS

	Page

Report of Independent Registered Public Accounting Firm	F-2

Consolidated Financial Statements:

Consolidated Balance Sheets	F-3

Consolidated Statements of Operations	F-4

Consolidated Statements of Shareholders’ Deficit	F-5

Consolidated Statements of Cash Flows	F-6

Notes to Consolidated Financial Statements	F-8 - F-27

	F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders

22nd Century Group, Inc.

We have audited the accompanying consolidated balance sheets of 22nd Century Group, Inc. and Subsidiary as of December 31, 2013 and 2012, and the related consolidated statements of operations, shareholders’ equity (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, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of 22nd Century Group, Inc. and Subsidiary as of December 31, 2013 and 2012, 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.

/s/ Freed Maxick CPAs, P.C.

Buffalo , New York

January 30, 2014

	F-2

22nd CENTURY GROUP INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

December 31,

	2013		2012

ASSETS
Current assets:
Cash	$	5,830,599	$	188
Due from related party		42,069		36,969
Due from officers		7,471		3,578
Inventory		1,406,280		1,230,526
Machinery and equipment held for resale		457,696		-
Prepaid expenses and other assets		-		10,044
Total current assets		7,744,115		1,281,305

Machinery and equipment, net		2,997,760		6,030

Other assets:
Patent and trademark costs, net		1,544,869		1,353,304
Deferred debt issuance costs, net		-		4,232
Total other assets		1,544,869		1,357,536

Total assets	$	12,286,744	$	2,644,871

LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Demand bank loan	$	174,925	$	174,925
Accounts payable		54,665		1,410,650
Accrued expenses		575,730		503,002
Deferred revenue		179,014		-
Accrued interest payable to related parties		-		3,567
Notes payable		-		617,000
Convertible notes, net of unamortized discount		-		1,893,804
Total current liabilities		984,334		4,602,948

Warrant liability		3,779,522		4,173,140
Total liabilities		4,763,856		8,776,088

Commitments and contingencies (Note 12)		-		-

Shareholders' equity (deficit)
Capital stock authorized:
10,000,000 preferred shares, $.00001 par value
300,000,000 common shares, $.00001 par value
Capital stock issued and outstanding:
0 convertible preferred shares, $1,000 stated value,
10% cumulative (0 at December 31, 2012)		-		-
56,902,770 common shares (34,286,979 at December 31, 2012)		569		344
Capital in excess of par value		47,452,055		7,645,017
Accumulated deficit		(39,929,736)		(13,776,578)
Total shareholders' equity (deficit)		7,522,888		(6,131,217)

Total liabilities and shareholders' equity (deficit)	$	12,286,744	$	2,644,871

See accompany notes to consolidated financial statements.

	F-3

22nd CENTURY GROUP INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS

Years Ended December 31,

		2013		2012


Revenue:
Royalties from licensing	$	7,000,000	$	-
Sale of products		278,383		18,775
		7,278,383		18,775

Cost of goods sold:
Royalties for licensing		413,566		-
Products		48,105		67,967
		461,671		67,967

Gross profit (loss)		6,816,712		(49,192)

Operating expenses:
Research and development (including stock based compensation of $111,563 and $145,074, respectively)		744,230		729,225
General and administrative (including stock based compensation of $2,250,399 and $1,109,097, respectively)		4,106,694		2,205,450
Sales and marketing costs		9,052		61,876
Amortization and depreciation		144,289		198,406
		5,004,265		3,194,957

Operating income (loss)		1,812,447		(3,244,149)

Other income (expense):
Warrant liability loss - net		(23,602,711)		(1,998,043)
Warrant exchange inducement expense		(3,736,313)		-
Income tax credit refund		122,024		-
Interest expense and amortization of debt discount and expense:
Related parties		(17,889)		(272,758)
Other		(730,716)		(1,221,787)
		(27,965,605)		(3,492,588)

Net loss		(26,153,158)		(6,736,737)

Net loss attributable to non-controlling interest		-		1,456

Net loss attributed to common shareholders	$	(26,153,158)	$	(6,735,281)

Loss per common share - basic and diluted	$	(0.60)	$	(0.22)

Common shares used in basic earnings per share calculation		43,635,182		30,419,556

See accompany notes to consolidated financial statements.

	F-4

22nd CENTURY GROUP INC. AND SUBSIDIARY

CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT)

Years Ended December 31, 2013 and 2012

	Preferred		Common		Par value		Par value
	Shares		Shares		of Preferred		of Common		Contributed		Accumulated		Non-controlling		Shareholders'
	Outstanding		Outstanding		Shares		Shares		Capital		Deficit		Interest		Equity (Deficit)
Balance at December 31, 2011		-		27,209,646	$	-	$	273	$	5,822,882	$	(7,041,297)	$	5,982	$	(1,212,160)

Stock base compensation under Equity Incentive Plan		-		700,000		-		7		722,202		-		-		722,209

Options granted for payment of services		-		-		-		-		10,000		-		-		10,000

Common stock issued as payment of services and accounts payable		-		1,267,500		-		13		517,740		-		-		517,753

Common stock issued upon exercise of Convertible Notes		-		161,000		-		2		(2)		-		-		-

Common stock issued in May 2012 private placement		-		1,710,833		-		17		(17)		-		(4,526)		(4,526)

Beneficial conversion feature of convertible debt		-		-		-		-		116,600		-		-		116,600

Common stock issued in November 2012 private placement		-		3,238,000		-		32		455,612		-		-		455,644

Net loss		-		-		-		-		-		(6,735,281)		(1,456)		(6,736,737)

Balance at December 31, 2012		-		34,286,979	$	-	$	344	$	7,645,017	$	(13,776,578)	$	-	$	(6,131,217)

Common stock issued upon exercise of Convertible Notes		-		2,406,720		-		24		(24)		-		-		-

Preferred stock issued in January 2013 private placement		2,500		416,666		-		4		(4)		-		-		-

Conversion of preferred stock to common stock		(2,500)		4,166,666		-		42		(42)		-		-		-

Exercise of warrants		-		6,820,218		-		68		14,097,526		-		-		14,097,594

Exercise of options		-		20,000		-		-		5,200		-		-		5,200

Stock based compensation		-		2,820,000		-		28		2,361,934		-		-		2,361,962

Other contributed capital		-		-		-		-		1,660		-		-		1,660

Warrant exchange program		-		5,804,368		-		58		23,340,789		-		-		23,340,847

Common stock issued in payment of accrued dividends		-		161,153		-		1		(1)		-		-		-

Net loss		-		-		-		-		-		(26,153,158)		-		(26,153,158)

Balance at December 31, 2013		-		56,902,770	$	-	$	569	$	47,452,055	$	(39,929,736)	$	-	$	7,522,888

See accompanying notes to consolidated financial statements.

	F-5

22nd CENTURY GROUP INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31,

		2013		2012
Cash flows from operating activities:
Net loss	$	(26,153,158)	$	(6,736,737)
Adjustments to reconcile net loss to cash provided by (used in) operating activities:
Amortization and depreciation		144,289		198,406
Amortization of debt issuance costs		4,232		18,173
Amortization of debt discount		134,296		1,372,018
Interest due to debt conversion		526,448		31,350
Warrant liability loss		23,602,711		1,998,043
Warrant exchange inducement expense		3,736,313		-
Equity based employee compensation expense		980,162		807,675
Equity based payments for outside services		1,381,800		416,496
Stock issued for director fees		-		30,000
(Increase) decrease in assets:
Inventory		(175,754)		(552,403)
Prepaid expenses and other assets		10,044		7,630
Increase (decrease) in liabilities:
Accounts payable		(629,101)		705,415
Accrued interest payable to related parties		(3,567)		(2,470)
Accrued expenses		118,105		(58,041)
Deferred revenue		179,014		-
Net cash provided by (used in) operating activities		3,855,834		(1,764,445)
Cash flows from investing activities:
Acquisition of patents and trademarks		(290,336)		(162,774)
Purchase of machinery and equipment held for resale		(457,696)		-
Acquisition machinery and equipment		(2,994,757)		-
Net cash used by investing activities		(3,742,789)		(162,774)
Cash flows from financing activities:
Proceeds from issuance of notes		150,000		56,000
Payments on borrowings - notes payable		(1,620,299)		(41,000)
Payments on borrowings - convertible notes		(339,250)		-
Net proceeds from May and November 2012 private placement		-		1,467,500
Proceeds from issuance of convertible notes		-		210,000
Net proceeds from January 2013 preferred stock private placement		2,034,664		-
Net proceeds from exercise of warrants		2,254,999		-
Net proceeds from warrant exchange program		3,239,385		-
Net proceeds from exercise of options		5,200		-
Other capital contribution		1,660		-
Net payments to related party		(5,100)		(21,478)
Net advances (to) from officers		(3,893)		4,136
Net cash provided by financing activities		5,717,366		1,675,158
Net increase (decrease) in cash		5,830,411		(252,061)
Cash - beginning of year		188		252,249
Cash - end of year	$	5,830,599	$	188

Cash paid during the year for interest	$	135,247	$	15,317
Cash paid during the year for income taxes	$	-	$	-

	F-6

Supplemental disclosure of noncash investing and financing activities:
Reduction of accounts payable not related to operating activities:
Common stock issued as payment of accounts payable	$	-	$	359,754
Accounts payable converted to promissory notes		769,377		-
	$	769,377	$	359,754

Accrued interest converted to promissory notes	$	26,422	$	-

Deferred private placement costs charged to contributed capital	$	-	$	4,526

Notes payable and accrued interest converted to common shares	$	1,650,305	$	120,750

Original issue discount on convertible debt	$	-	$	12,600

Beneficial conversion value upon issuance of convertible debt recorded as debt discount and an increase in capital in excess of par value	$	-	$	116,600

Common stock issued for fees relating to January 2013 preferred stock private placement	$	416,666	$	-

Common stock issued for fees relating to December 2013 warrant exchange program	$	462,000	$	-

Common stock issued in payment of preferred stock dividend payable	$	93,361	$	-

Refinance of convertible note to note payable	$	57,500	$	-

Issuance of warrants as derivative liability instruments and reduction of capital	$	5,675,634	$	1,532,347

Increase in warrant liability and reduction in capital as a result of lowering the exercise price on certain warrants	$	626,328	$	-

Issuance of warrants as derivative liability instruments	$	-	$	92,750

Reclassification of derivative liability to equity due to warrant exercise	$	14,433,178	$	-

Reclassification of derivative liability to equity due to warrant exchange program	$	19,639,465	$	-

Patent and trademark additions included in accounts payable	$	42,490	$	-

See accompanying notes to consolidated financial statements.

	F-7

22nd CENTURY GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2013

NOTE 1. - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation - The accompanying consolidated financial statements include the accounts of 22nd Century Group, its wholly owned subsidiary, 22nd Century Ltd, and 22nd Century Ltd’s wholly owned subsidiaries, Goodrich Tobacco Company, LLC (“Goodrich Tobacco”) and Hercules Pharmaceuticals, LLC (“Hercules Pharma”) (collectively, “the Company”) . In May 2012, 22nd Century Ltd acquired from an employee the non-controlling membership units of Goodrich Tobacco that it did not own so that Goodrich Tobacco became a wholly owned subsidiary . All intercompany accounts and transactions have been eliminated.

Nature of Business - 22nd Century Ltd, is a plant biotechnology company specializing in technology that allows for the level of nicotine and other nicotinic alkaloids (e.g., nornicotine, anatabine and anabasine) in tobacco plants to be decreased or increased through genetic engineering and plant breeding. The Company owns or exclusively controls 114 issued patents in 78 countries plus an additional 38 pending patent applications . Goodrich Tobacco and Hercules Pharma are business units for the Company’s (i) premium cigarettes and potential modified risk tobacco products and (ii) smoking cessation product, respectively.

Reclassifications - Certain items in the 2012 financial statements have been reclassified to conform to the 2013 classification.

Preferred Stock Authorized - the authorization is for “ blank check” preferred stock, which could be issued with voting, liquidation, dividend and other rights superior to our common stock. On January 11, 2013 the Company designated the rights of and issued 2,500 shares of Series A-1 Preferred Stock. As of June 7, 2013, all 2,500 outstanding shares of Series A-1 Preferred Stock were converted into an aggregate 4,166,666 shares of common stock of the Company (see Note 3) and no shares of preferred stock remain outstanding.

Inventory - Inventories are valued at the lower of cost or market. Cost is determined on the first-in, first-out (FIFO) method. Inventories are evaluated to determine whether any amounts are not recoverable based on slow moving or obsolete condition and are written off or reserved as appropriate. As of December 31, 2013 and 2012, the Company’s inventory consisted primarily of raw materials, mainly tobacco.

Fixed assets – Fixed assets are recorded at their acquisition cost and depreciated on a straight line basis over their estimated useful lives ranging from 5 to 10 years. Depreciation commences when the asset is placed in service. Cigarette manufacturing equipment purchased in December 2013 in the amount of $ 2,762,304 was not placed in service at December 31, 2013 and accordingly, no depreciation was taken. Certain cigarette manufacturing equipment with a cost of $ 457,696 will not be used in the Company’s operations and has been recorded as “Machinery and equipment held for resale” on the Company’s Balance Sheet at December 31, 2013.

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, as well as costs to acquire patent rights from third parties. The amounts capitalized relate to intellectual property that the Company owns or to which it has exclusive rights. The Company’s intellectual property capitalized costs are amortized using the straight-line method over the remaining statutory life of the primary patent in each of the Company’s two largest patent families, which expires in 2019 and 2028 (the assets’ estimated lives). Periodic maintenance or renewal fees are expensed as incurred. Annual minimum license fees are charged to expense. Total patent and trademark costs capitalized at December 31, 2013 and 2012 consist of the following:

During the year ended December 31, 2013, the Company changed the estimated useful life of one of the patent families. The change did not have a material impact on the financial statements.

		December 31,		December 31,
		2013		2012

Patent and trademark costs	$	2,559,412	$	2,226,586
Less: accumulated amortization		1,014,543		873,282

Patent and trademark costs, net	$	1,544,869	$	1,353,304

	F-8

The estimated annual amortization expense for the next five years is approximately $ 177,000 .

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 year ended December 31, 2013 or 2012.

Income Taxes - The Company recognizes deferred tax assets and liabilities for any basis differences in its assets and liabilities between tax and GAAP reporting, and for operating loss and credit carry-forwards.

In light of the Company’s history of cumulative net operating losses and the uncertainty of their future utilization, the Company has established a valuation allowance to fully offset its net deferred tax assets as of December 31, 2013 and 2012.

The Company’s federal and state tax returns for the years ended September 30, 2011 to December 31, 2012 are currently open to audit under the statutes of limitations. There are no pending audits as of December 31, 2013.

Refundable taxes and tax credits – The Company accounts for income tax refunds or tax refundable tax credits as discrete items and recognized the amount in the period in which the funds are received. During the year ended December 31, 2013, the Company received notice from the New York State Department of Taxation and Finance of a no change audit with respect to its income tax return filed for the period ending September 30, 2011. The subject return contained a refundable credit in the amount of $ 122,000 . The refund was recorded as other income in the Company’s consolidated statement of operations. There were no such transactions during the year ended December 31, 2012.

Stock Based Compensation - The Company uses a fair-value based method to determine compensation for all arrangements under which Company employees and others receive shares, options or warrants to purchase common shares of 22nd Century Group. Stock based compensation expense is recorded over the requisite service period based on estimates of probability and time of achieving milestones and vesting. For accounting purposes, the shares will be considered issued and outstanding upon vesting.

Debt Discounts - Original issue discount (“OID”) is recorded equal to the difference between the cash proceeds, after allocation to warrants issued or issuable upon payment of the debt, and the face value of the debt when issued and amortized as interest expense during the term of the debt.

When the convertible feature of the conventional convertible debt is issued, the embedded conversion feature is evaluated to determine if bifurcation and derivative treatment is required and whether there is a beneficial conversion feature. When the convertible debt provides for an effective rate of conversion that is below market value, this feature is characterized as a beneficial conversion feature (“BCF"). Prior to the determination of the BCF, the proceeds from the debt instrument were first allocated between the convertible debt and any embedded or detachable free standing instruments that are included, such as common stock warrants. The proceeds allocated to any warrants are recorded as a debt discount.

The debt discount is amortized to interest expense over the life of the debt. In the case of any conversion prior to the maturity date there will be an unamortized amount of debt discount that relates to such conversion. The pro rata amount of unamortized discount at the time of such conversion is charged to interest expense as accelerated amortization of the discount. The fair value of warrants issued at the time of conversion is recorded as a reduction of the amount applied to the common stock issued in the conversion and to the extent that the fair value of warrants exceeds the carrying value of the debt a charge to interest expense results for such excess amount.

Revenue Recognition - The Company recognizes revenue from product sales at the point the product is shipped to a customer and title has transferred. Revenue from the sale of the Company’s products is recognized net of cash discounts, sales returns and allowances. Cigarette federal excise taxes are included in net sales and accounts receivable billed to customers, except on sales of SPECTRUM research cigarettes and exported cigarettes in which such taxes do not apply.

	F-9

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. These government research cigarettes are distributed under the Company’s mark, SPECTRUM . The Company delivered approximately 12 million SPECTRUM research cigarettes during the year ended December 31, 2012 and 2011 and recognized the related revenue of approximately $ 807,000 . There were no SPECTRUM cigarettes delivered during the year ended December 31, 2013. Future revenue under this arrangement is expected to be related to the delivery of SPECTRUM and will be recognized at the point the product is shipped and title has transferred. In September 2013, the Company received a purchase order for an additional 5.5 million SPECTRUM research cigarettes that will be manufactured and shipped in January 2014. Total revenue from this order will be approximately $ 448,000 and a down payment on the order was received in the fourth quarter of 2013 in the amount of $ 179,014 . The down payment has been recorded as deferred revenue on the Company’s balance sheet at December 31, 2013.

The Company licenses its patented technology to third parties. Revenue is recognized from licensing arrangements as contractually defined in licensing agreements. The Company accounts for milestones elements contained in licensing agreements in accordance with ASC 605. On October 1, 2013, 22nd Century Ltd entered into a worldwide Research License and Commercial Option Agreement (the “Agreement”) with British American Tobacco (Investments) Limited (“BAT”), a subsidiary of British American Tobacco plc, that grants BAT access to 22nd Century Ltd’s patented technology which alters levels of nicotinic alkaloids in tobacco plants. Simultaneous with the signing of the Agreement, BAT paid the Company a non-refundable $ 7,000,000 . The Company will be entitled to receive additional payments from BAT of up to an additional $ 7,000,000 during the term of the Research License in the event certain milestones are met by BAT with respect to its research and development of the patent rights and licensed intellectual property rights licensed by the Company to BAT. No amount related to the additional research milestones were recognized during 2013. During the term of the Research License, BAT will have the option to enter into a Commercial License agreement which will provide for future royalty payments based on sales. 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 agreement of 22nd Century Ltd and the third party licensor.

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 on the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument could be required within twelve months of the balance sheet date.

Research and Development - Research and development costs are expensed as incurred.

Loss Per Common Share - Basic loss per common share is computed using the weighted-average number of common shares outstanding. Diluted loss per share is computed assuming conversion of all potentially dilutive securities. Potential common shares outstanding are excluded from the computation if their effect is anti-dilutive.

Commitment and Contingency Accounting - The Company evaluates each commitment and/or contingency in accordance with the accounting standards, which state that if the item is more likely than not to become a direct liability, then the Company will record the liability in the financial statements. If not, the Company will disclose any material commitments or contingencies that may arise.

Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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.

	F-10

Fair Value of Financial Instruments - Financial instruments include cash, receivables, accounts payable, accrued expenses, notes payable, demand bank loan, convertible notes payable and warrant liability. Other than warrant liability and convertible notes payable, fair value is assumed to approximate carrying values for these financial instruments, since they are short term in nature, they are receivable or payable on demand, or had stated interest rates that approximate the interest rates available to the Company as of the reporting date. The determination of the fair value of the warrant liability includes unobservable inputs and is therefore categorized as a Level 3 measurement, as further discussed in Note 10. There are no convertible notes outstanding at December 31, 2013.

NOTE 2. – FINANCIAL CONDITION

At December 31, 2013, the Company had current assets of $ 7,744,115 and current liabilities of $ 984,334 resulting in positive working capital of $ 6,759,781 . Cash on hand at December 31, 2013 was $ 5,830,599 . During the year ended December 31, 2013, the Company has improved its balance sheet and cash position primarily through a series of equity transactions that realized net proceeds of approximately $ 7,529,000 and completion of a worldwide Research License and Commercial Option Agreement generating gross royalties of $ 7,000,000 . As a result of the above referenced transactions, 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.

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.

	F-11

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 loss – 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 resulted 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 loss – 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 an 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 (“ Warrant Exercise Agreement”). 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. At December 31, 2013, management estimated the fair value of the instrument to be zero primarily as a result of the increase in the underlying value of the Company’s common stock and the short period of time remaining to the date of the Measurement Price. Accordingly, the Company reversed the $ 290,000 current liability at December 31, 2013 that was established at 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 $ 3,172,000 . As a result of this Warrant Exercise Agreement, an additional $ 60,000 commission was paid to Chardan Capital Markets, LLC.

	F-12

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 $ 1,074,670 . 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 $ 608,419 . Between October 3, 2013 and December 26, 2013, the Series A Warrant holder exercised on a cashless basis at $ 0.60 per share 3,678,889 Series A warrants resulting in the issuance of 1,972,976 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 $ 7,712,170 .

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 year ended December 31, 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, which has been reflected as a reduction of the equity proceeds.

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 and NOVEMBER 2012 PRIVATE PLACEMENT

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: $ 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: $ 681,000 in cash, cancellation by vendors of $ 98,500 in accounts payable and cancellation of $ 30,000 in directors fees owed to two 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 a total of 1,080,000 shares and 540,000 warrants for $ 270,000 in cash. Two directors of the Company acquired a total of 120,000 shares and 60,000 warrants in lieu of payment of $ 30,000 of director fees.

	F-13

NOTE 5. – MACHINERY AND EQUIPMENT

Machinery and equipment at December 31, 2013 and 2012 consists of the following:

	December 31,		December 31,
	2013		2012
Cigarette manufacturing equipment	$	3,220,000	$	-
Office furniture, fixtures and equipment		17,059		9,106
Leasehold improvements		14,500		-
Deposit for purchase of machine parts and other assets		210,000		-
		3,461,559		9,106
Less: cigarette manufacturing equipment held for resale		457,696		-
		3,003,863		9,106
Less: accumulated depreciation		6,103		3,076
Machinery and equipment, net	$	2,997,760	$	6,030

On December 11, 2013, the Company closed on a $ 3,220,000 purchase of certain cigarette manufacturing equipment from a company located in North Carolina that was liquidating under Chapter 7 of the U.S. Bankruptcy Code. A certain portion of the equipment will not be required for the Company’s cigarette manufacturing operations and will be subsequently listed for sale in the first quarter of 2014 in order to offset the purchase price of the equipment. The Company allocated $ 457,696 of the purchase price to these assets and classified them as machinery and equipment held for resale in the current asset section of the balance sheet at December 31, 2013. The remaining cigarette manufacturing equipment, with a cost of $ 2,762,304 , was not placed in service as of December 31, 2013, and accordingly, no depreciation was recorded.

In December 2013, the Company made a $210,000 deposit to the bankruptcy trustee of a company located in North Carolina that is liquidating under Chapter 11 of the U.S. Bankruptcy Code to purchase various cigarette manufacturing equipment parts, office furniture and fixtures, vehicles and computer software and equipment. On January 13, 2014, the transaction closed and the Company successfully purchased the subject assets for the amount of the $ 210,000 deposit.

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 executive officer of the Company. This loan had a balance of $ 174,925 at December 31, 2013 and 2012. The Company is required to pay interest monthly at an annual rate of 0.75 % above the prime rate, or 4.00 % at December 31, 2013 and 2012. The Company is current in meeting this interest payment obligation. The terms of the demand loan includes 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.

	F-14

NOTE 7. - NOTES PAYABLE

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

		December 31,		December 31,
		2013		2012

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

Notes payable	$	-	$	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 was due on October 1, 2013 together with accrued interest. 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 with a principal balance of $ 175,000 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. 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 by the Company 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 was 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 leaving the note principal balance at $ 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.

	F-15

Note Dated January 23, 2013 (unsecured) - On January 23, 2013, the Company issued a $ 150,000 note to an 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. 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 issued a note to a vendor in the amount of $ 474,893 as satisfaction of past due invoices previously recorded by the Company in accounts payable. The note bears interest at an annual rate of 5 %. The outstanding principal and accrued interest is due on October 1, 2013 or sooner if the Company closes an in-licensing agreement in which the Company or any affiliate receives an up-front payment of at least $1.5 million. On October 2, 2013, the Company made a payment to the note holder in the amount of $ 490,701 in full satisfaction of the note and all accrued interest.

NOTE 8. - CONVERTIBLE NOTES

ISSUED DECEMBER 14, 2011

The Company issued convertible notes on December 14, 2011 in a negotiated sale with 24 investors in the total face amount of $ 1,926,250 (“Convertible Notes”). The Convertible Notes were sold for $ 1,675,000 - an original issue discount of $ 251,250 . The Convertible Notes did not bear interest and the total face amount was due December 14, 2012 . The Convertible Notes could be converted, at the option of each holder, in whole or in part, into shares of the Company’s common stock at $ 0.75 per share at which time the holder shall also receive warrants equal to 120 % of the number of shares of Company common stock into which such Convertible Notes have been then converted. The Company could also force the investors to decide whether to convert by sending a 15-day written notice in which each investor is forced to decide whether to convert or receive payment in full. Such warrants have a term of five years and an exercise price of $ 1.50 per share of common stock. The Convertible Notes contained “down round” provisions which provided for adjustments to the conversion price if the Company issues shares of common stock of 22nd Century Group at a price that is less than the exercise price. The conversion feature was not considered to be a derivative because it does not have a net cash settlement provision as a result of the limited market and trading activity for the underlying stock at this time.

The Company’s common stock closed at $ 0.90 per share on December 14, 2011, which is greater than the portion of the conversion price under the Convertible Notes allocated to the underlying common shares. This difference is a beneficial conversion feature (BCF) which was valued at $ 1,062,758 at the issue date and recorded as debt discount and additional paid in capital. This BCF was amortized over the one year life of the Convertible Notes.

Three of the Company’s executive officers at the time of issuance acquired a portion of the Convertible Notes - with a face value of $ 368,000 , for cash of $ 105,000 and conversion of $ 215,000 short term unsecured 12 % notes issued by the Company earlier in 2011.

As of December 31, 2012, the OID and BCF discounts were fully amortized, and therefore no amortization was recorded during the year ended December 31, 2013. During the year ended December 31, 2012, $ 1,284,363 of the debt discount was amortized and recorded as interest expense related to the OID and BCF discounts.

During the year ended December 31, 2012, a portion of the Convertible Notes with a face amount of $ 120,750 (carrying value at time of conversion of approximately $ 55,000 , net of unamortized discount) were converted into 161,494 shares of common stock and warrants to purchase 193,793 shares of common stock. As a result of the conversion, the unamortized portion of the debt discount amounting to approximately $ 66,000 was immediately charged to interest and a derivative warrant liability valued at approximately $ 152,000 was recorded. The difference in the warrant value and debt relieved amounting to approximately $ 31,000 was also charged to interest expense. Included in conversions of the Convertible Notes during the year ended December 31, 2012 was a note converted by an officer with a face amount of $86,250 converted into 115,000 shares of common stock and warrants to purchase 138,000 shares of common stock.

	F-16

At December 31, 2012, Convertible Notes with a total face and carrying value of $ 1,805,500 remained outstanding; of this amount $ 1,523,750 were extended by agreement with the note holders to April 14, 2013 at 15 % interest per annum. Two convertible note holders did not execute agreements to extend their notes. In connection with the issuance of the Series A-1 Preferred Stock in January 2013, the Convertible Note holders entered into lock-up agreements with the Company and received additional warrants (five year term at $ 1.50 exercise price) to purchase 219,909 shares of common stock, and have the same rights as the warrants in the original December 2011 Convertible Note agreement. The lock-up agreement restricted the Convertible Note holders’ ability to sell any of the shares received as a result of the conversion of the Convertible Notes.

Of the $ 1,805,500 in convertible notes outstanding at December 31, 2012, $ 1,408,750 of the Convertible Notes (together with accrued interest) were converted into 2,035,720 shares of common stock and five-year warrants (which includes lock-up warrants) to purchase 2,662,769 shares of common stock at $ 1.50 per share during the period from January 1, 2013 to February 6, 2013. The Company discharged the remaining convertible notes of $ 396,750 by payments in cash of $ 339,250 and the Company refinanced $ 57,500 into a new note that was paid in full in July 2013. Of the Convertible Notes paid in cash, $ 247,250 was held by an executive officer. The executive officer subsequently issued the Company a new promissory note in the amount of $ 150,000 that matured on October 1, 2013 (see Note 7). None of the Convertible Notes issued on December 14, 2011 remain outstanding as of December 31, 2013.

ISSUED AUGUST 9, 2012

The Company issued convertible notes on August 9, 2012 in a negotiated sale with 4 investors in the total face amount of $ 222,600 . The convertible notes were sold for $ 210,000 - an original issue discount (OID) of $ 12,600 . The convertible notes did not bear interest and the total face amount was due August 9, 2013 together with warrants equal to 50% of the number of shares of Company common stock into which such convertible notes are converted. These warrants were valued at $ 92,750 and represent additional debt discount and warrant liability. The convertible notes can be converted, at the option of each holder, in whole or in part, into shares of the Company’s common stock at $ 0.60 per share at which time the holder shall also receive warrants equal to 100 % of the number of shares of Company common stock into which such convertible notes are converted. Additional warrants issued as a result of conversion will be valued and recorded as a warrant liability at that time and will reduce the equity recorded as a result of the conversion. In the event the warrant value exceeds the amount of equity, an immediate charge to other expense will be recorded. The warrants issued upon conversion or maturity will have a term of five years and an exercise price of $ 1.00 per share of common stock. The conversion feature was not considered to be a derivative because it does not have a net cash settlement provision as a result of the limited market and because of the trading activity for the underlying stock at the time. The warrants to be issued upon conversion or maturity have a “down round provision” and will be classified as derivatives for accounting purposes, and are reported as a liability and marked to market at each balance sheet date.

The Company’s common stock closed at $ 0.45 per share on August 9, 2012, which is greater than the portion of the conversion price under the convertible notes allocated to the underlying common shares. This difference is a beneficial conversion feature (BCF) which was valued at $ 116,600 at the issue date and recorded as debt discount and additional paid in capital. This BCF is being amortized over the one year life of the convertible notes.

During the years ended December 31, 2013 and 2012, $134,296 and $ 87,654 of debt discount was amortized and recorded as interest expense related to the OID, warrant and BCF discounts, leaving no unamortized debt discount as of December 31, 2013.

During August 2013, all of the convertible notes issued on August 9, 2012 with a carrying value of $ 222,600 were converted into 371,000 shares of common stock and five-year warrants to purchase 371,000 shares of common stock at $ 1.00 per share.

	F-17

The warrants issued in conjunction with the note conversions during August 2013 were recorded at fair value at the time of issuance amounting to $ 731,662 . Since the warrants are considered a derivate liability, the excess of the fair value of the warrants at the time of issuance above the face amount of the notes converted was immediately recorded as additional interest expense in the amount of $ 509,062 .

The following table summarizes convertible notes and related discount.

	December 31,		December 31,
	2013		2012

Face value of all convertible notes payable through maturity	$	-	$	2,028,100
Less unamortized original issue discount		-		(63,787)
Less unamortized discount related to BCF		-		(70,509)
Convertible Notes, net of unamortized debt discount	$	-	$	1,893,804

Carrying value of December 14, 2011 Convertible Notes	$	-	$	1,805,500
Carrying value of August 9, 2012 Convertible Notes	$	-	$	88,304

NOTE 9. - DUE FROM RELATED PARTY

The Company has conducted transactions with a related party, Alternative Cigarettes, Inc. (“AC”). AC is entirely owned by certain shareholders of the Company, including the CEO. AC shares office space and employee services with the Company. During the year ended December 31, 2011 the Company acquired its MAGIC trademark from AC for a purchase price of $ 22,500 . During the years ended December 31, 2013 and 2012, transactions with AC consisted mainly of repayments and advances. The net amount due from AC amounted to $ 42,069 as of December 31, 2013 ($ 36,969 as of December 31, 2012). No interest has been accrued or paid on amount due from or to AC and there are no repayment terms.

NOTE 10. - WARRANT EXCHANGE PROGRAM AND WARRANTS FOR COMMON STOCK

WARRANT EXCHANGE PROGRAM

The Company had 19,616,308 warrants for common stock outstanding at September 30, 2013. These warrants contain “down round” provisions and anti-dilution features that provide for adjustments to the exercise price and number of warrants outstanding if the Company issues common shares of stock of 22nd Century Group at a price that is less than the respective warrant exercise prices. These provisions require that these warrants be classified as derivatives for accounting purposes, which means they are reported as a liability and adjusted to fair value at each balance sheet date. On November 14, 2013, the Company initiated a warrant exchange program (the “Warrant Exchange Program”) with the goal of reducing the Company’s warrant liability. To that end, the Company offered financial inducements to certain warrant holders to (1) exercise their warrant on a cash basis, (2) exercise their warrant on a cashless basis, or (3) agree to have the “down round provision” or anti-dilution feature removed from their warrant in exchange for additional warrant coverage. The warrants holders also had the option to maintain the terms and conditions of their original warrant. Management and the Company’s Board of Directors were prohibited from participating in the Warrant Exchange Program. As a result of the cash and cashless exercise of warrants, there is a reduced number of outstanding warrants, and as a result of the removal of the “down round” provisions and anti-dilution features on other warrants, they are no longer required to be classified as a derivative liability. The Warrant Exchange Program that ended on December 12, 2013, generated gross proceeds of $ 3,559,763 and resulted in the issuance of 5,348,172 shares of the Company’s common stock from the cash exercise of warrants. The issuance of 156,197 shares of the Company’s common stock resulted from the exercise of 513,949 warrants that were exercised on a cashless basis. As an inducement for warrant holders to agree to remove their “down round” provision and anti-dilutions feature from their warrant, 138,666 additional warrants were issued. As a result of the Warrant Exchange Program, there are 6,732,088 warrants outstanding at December 31, 2013 that do not contain the “down round” provisions or anti-dilution features. The Company calculated the cost of inducement as the difference between the fair value of the warrants immediately after the Warrant Exchange Program was closed on December 12, 2013, less the fair value of the warrants immediately prior to Warrant Exchange Program completion. The Company estimated the total cost of inducement to be $ 3,736,313 , and this expense has been recorded as an “Other Expense” on the consolidated statements of operations and as an increase to the derivative warrant liability, and subsequently reversed into capital. The Company paid $ 320,378 and issued 300,000 shares of the Company’s common stock to Chardan Capital Markets, LLC (“Chardan”) in conjunction with the Warrant Exchange Program. The fair value of the 300,000 shares issued to Chardan in the amount of $ 462,000 is included as a component of the total cost of inducement.

	F-18

WARRANTS FOR COMMON SOCK

In connection with the January 25, 2011 Private Placement and reverse merger into a public company, the Company issued five year warrants (“January 25, 2011 Warrants”) to purchase shares of common stock of 22nd Century Group. These warrants contain “down round” provisions and anti-dilution features which provide for adjustments to the exercise price if the Company issues common shares of stock of 22nd Century Group at a price that is less than the respective warrant exercise prices. This provision and features require these warrants be classified as derivatives for accounting purposes, which means they are reported as a liability and marked to market at each balance sheet date. As a result of the equity securities issued during 2012, the “down round” provision and anti-dilution feature of the January 25, 2011 Warrants were triggered and the adjusted warrants outstanding as of December 31, 2012 were 5,482,055 with an exercise price of $ 2.73 per share and 3,947,232 with an exercise price of $ 1.39 per share. As a result of equity securities issued during the year ended December 31, 2013, the cashless conversion of 1,160,080 warrants during the third quarter of 2013, and the effects of the Warrant Exchange Program, the January 25, 2011 Warrants now amount to 3,455,039 warrants with an exercise price of $ 2.21 per share, 3,062,665 warrants with an exercise price of $ 1.96 per share, 110,336 warrants with an exercise price of $ 1.20 per share and 374,007 warrants with an exercise price of $ 1.27 per share outstanding as of December 31, 2013. As a result of the Warrant Exchange Program, 3,437,072 of these warrants no longer contain the “down round” provision and anti-dilution feature. The warrants affected by the Warrant Exchange Program resulted in a reduction of the warrant liability and an increase in capital in the amount of $ 4,612,263 after inducement. The cashless exercise of the 1,160,080 warrants resulted in a reduction of the warrant liability and an increase in capital in the amount of $ 482,654 .

During 2012, 193,200 warrants at an original exercise price of $ 1.50 were issued upon partial conversion of the December 14, 2011 Convertible Notes, which include “down round” provisions and resulted in a derivative liability upon issuance of approximately $ 152,000 . Due to subsequent issuance of common stock and instruments convertible into common stock, and the effects of the Warrant Exchange Program, the number of warrants issuable and their exercise price has been adjusted. As of December 31, 2013, warrants issued during 2012 related to partial conversion of the December 14, 2011 Convertible Notes now amount to 180,047 warrants outstanding with an exercise price of $ 1.15 per share. These outstanding warrants have retained their “down round” provision and anti-dilution feature. The warrants affected by the Warrant Exchange Program resulted in a reduction of the warrant liability and an increase in capital in the amount of $ 158,919 after inducement.

Between January 2, 2013 and February 6, 2013 Convertible Notes issued on December 14, 2011 with a carrying value of $ 1,408,750 (together with accrued interest) were converted into 2,035,720 shares of common stock and five-year warrants to purchase 2,662,769 shares of common stock at $ 1.50 per share. The number of warrants issued upon conversion includes 219,909 lock-up warrants with the same rights as the December 14, 2011 Convertible Notes warrants. These warrants include a “down round” provision and resulted in a derivative liability upon conversion of $ 1,445,091 . As a result of equity securities issued in 2013 and the effects of the Warrant Exchange Program there are now 802,215 warrants outstanding with an exercise price of $ 1.38 per share. As a result of the Warrant Exchange Program these warrants no longer contain their “down round” provision or anti-dilution feature. The warrants affected by the Warrant Exchange Program resulted in a reduction of the warrant liability and an increase in capital in the amount of $ 7,637,813 after inducement.

In May 2012, the Company issued 1,710,833 five-year warrants to purchase common stock in a private placement with an original exercise price of $ 1.00 . These warrants contain a “down round” provision and anti-dilution feature and resulted in a derivative liability upon issuance of approximately $ 1,841,000 . The Company issued 124,217 lock-up warrants to the holders of May 2012 private placement warrants with the same rights as the warrants originally issued. The exercise price of the May 2012 warrants and lock-up warrants was adjusted as a result of subsequent equity securities issued at a lower price than the original exercise price. As a result of the Warrant Exchange Program and the cash exercise of 275,000 warrants during the third quarter of 2013, there remains 974,201 warrants with an exercise price of $ 0.60 per share outstanding as of December 31, 2013. As a result of the Warrant Exchange Program these warrants no longer contain their “down round” provision and anti-dilution feature. The $ 165,000 cash exercise of the 275,000 warrants resulted in a reduction of the warrant liability and an increase in capital in the amount of $ 421,817 . The warrants affected by the Warrant Exchange Program resulted in a reduction of the warrant liability and an increase in capital in the amount of $ 3,013,587 .

	F-19

Convertible notes issued in August 2012 entitled the holders to at least 185,500 warrants and up to 371,000 warrants (five-year warrants with an exercise price of $ 1.00 per share), which resulted in a derivative liability of $ 92,750 recorded at the time the notes were issued. In connection with the conversion of the August 9, 2012 convertible notes during August 2013, the Company issued 371,000 five-year warrants with an exercise price of $ 1.00 per share. These warrants include a “down round” provision and resulted in a derivative liability upon conversion of $ 731,662 . As a result of equity securities issued in 2013 and the effects of the Warrant Exchange Program, there are now 184,047 warrants outstanding with exercise prices of $ 0.96 . These outstanding warrants have retained their “down round” provision and anti-dilution feature. The warrants affected by the Warrant Exchange Program resulted in a reduction of the warrant liability and an increase in capital in the amount of $ 555,165 after inducement.

In November 2012, the Company issued 1,619,000 five-year warrants to purchase common stock in a private placement with an original exercise price of $ 1.00 . These warrants contain “down round” provision and anti-dilution feature and resulted in a derivative liability upon issuance of $ 353,747 . The Company issued 53,950 lock-up warrants to the holders of November 2012 private placement warrants with the same rights as the warrants originally issued. The exercise price of the November 2012 warrants and lock-up warrants was adjusted as a result of subsequent equity securities issued at a lower price than the original exercise price. As a result of the Warrant Exchange Program and the cashless exercise of 63,000 warrants in the third quarter of 2013, 1,518,600 warrants with an exercise price of $ 0.60 per share remain outstanding as of December 31, 2013. As a result of the Warrant Exchange Program these warrants no longer contain their “down round” provision and anti-dilution feature. The cashless exercise of the 63,000 warrants resulted in a reduction of the warrant liability and an increase in capital in the amount of $ 111,468 . The warrants affected by the Warrant Exchange Program resulted in a reduction of the warrant liability and an increase in capital in the amount of $ 3,661,718 .

The Company issued 6,250,000 warrants to purchase common stock in the January 2013 Series A-1 Preferred Stock private placement, including 4,166,666 Series A Warrants, which are five-year warrants with an exercise price of $ 0.72 per share and 2,083,334 Series B Warrants, which are one-year warrants with an exercise price of $ 0.60 per share. These warrants include a “down round” provision and an anti-dilution feature and resulted in a derivative liability upon issuance. The fair value of the Series A Warrants, Series B Warrants and the lock-up warrants issued to the May and November 2012 private placement warrant holders in conjunction with the January 2013 Series A-1 Preferred Stock private placement amounted to $ 6,022,319 . Further, 2,083,334 Series C Warrants are issuable upon exercise of the Series B Warrants. During June and July of 2013, 982,300 and 1,101,034 Series B Warrants, respectively, were exercised on a cash basis. The exercise of these Series B Warrants triggered the issuance of a like amount of Series C Warrants totaling 2,083,334 Series C Warrants. The Series C Warrant shares outstanding are exercisable at $ 0.72 and include a “down round” provision, which results in a derivative liability upon issuance. The fair value of the 982,300 Series C Warrant shares issued in June 2013, and the fair value of the 1,101,034 Series C Warrants issued in July 2013, amounted to $ 711,675 and $ 1,622,069 , respectively. On August 1, 2013, the Company entered into a Warrant Exercise Agreement (see Note 3 for a more detailed description of the Agreement) with 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 . 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 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 . The Series C Warrant holders exercised the cash option on August 5, 2013. In addition, between August and December 2013, the Series A and Series C Warrant holders exercised on a cashless basis at $ 0.60 per share 4,166,666 and 416,668 Series A and Series C Warrants, respectively. There are no Series A Warrants, Series B Warrants or Series C Warrants outstanding at December 31, 2013.

The Company estimates the value of warrant liability upon issuance of the warrants and at each balance sheet date using the binomial lattice model to allocate total enterprise value to the warrants and other securities in the Company’s capital structure. Volatility was estimated based on historical observed equity volatilities and implied (forward) or expected volatilities for a sample group of guideline companies and consideration of recent market trends. The following table is a roll-forward summary of the warrant liability:

	F-20

Fair value at December 31, 2011	$	550,000
Fair value of warrant liability upon partial conversion of December 14, 2011 Notes		152,100
Fair value of warrant liability upon issuance – May 15, 2012		1,841,000
Fair value of warrant liability related to minimum warrants issuable upon maturity of August 9, 2012 convertible notes		92,750
Fair value of warrant liability upon issuance – November 9, 2012		353,747
Loss as a result of change in fair value		1,183,543
Fair value at December 31, 2012	$	4,173,140
Fair value of warrant liability upon conversion of remaining December 14, 2011 Notes -– Q1 2013		1,445,091
Fair value of warrant liability upon issuance – Q1 2013		6,022,319
Fair value of warrant liability upon issuance – Q2 2013		711,675
Fair value of warrant liability upon issuance – Q3 2013		1,622,069
Fair value of warrant liability upon conversion of August 9, 2012 Notes -– Q3 2013		731,662
Fair value of warrant liability upon reduction of exercise price of Series A and Series C warrants – Q3 2013		626,328
Reclassification of warrant liability to equity upon exercise of warrants – Q2 2013		(204,513)
Reclassification of warrant liability to equity upon exercise of warrants – Q3 2013		(6,542,904)
Reclassification of warrant liability to equity upon exercise of warrants – Q4 2013		(7,712,170)
Cost of inducement from Warrant Exchange Program – Q4 2013		3,274,313
Reclassification of warrant liability to equity resulting from Warrant Exchange Program – Q4 2013		(19,639,465)
Loss as a result of change in fair value		19,271,977
Fair value at December 31, 2013	$	3,779,522

The aggregate net loss as a result of the Company’s warrant liability for the year ended December 31, 2013 amounted to $ 19,271,977 which is included in other income (expenses) as part of “warrant liability loss - net” in the accompanying consolidated statements of operations. The loss for the year ended December 31, 2013, also includes a charge to other income (expense) in the amount of $ 4,330,734 , as a result of (i) warrant liabilities issued in connection with the Series A-1 Preferred Stock in excess of net proceeds raised in the amount of $ 3,987,655 in January 2013, and (ii) warrant liabilities issued in connection with the July 2013 issuance of 1,101,034 Series C Warrants in excess of the sum of the net proceeds received upon exercise and the reclassification of the warrant liability to capital, in the amount of $ 343,079 . Warrant liabilities issued in connection with the December 14, 2011 Convertible Notes and the August 9, 2012 convertible notes converted to common stock in excess of the conversion amount by $ 17,386 and $ 509,062 , respectively, were recorded as additional interest expense.

ASC 820 - “Fair Value Measurements and Disclosures” establishes a valuation hierarchy for disclosure of the inputs to valuation used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows:

	·	Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.
	·	Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument.
	·	Level 3 inputs are unobservable inputs based on the Company’s own assumptions used to measure assets and liabilities at fair value.

A financial asset’s or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement. The warrant liability is measured at fair value using certain estimated factors such as volatility and probability which are classified within Level 3 of the valuation hierarchy. Significant unobservable inputs are used in the fair value measurement of the Company’s derivative warrant liabilities include volatility. Significant increases (decreases) in the volatility input would result in a significantly higher (lower) fair value measurement.

	F-21

The following table summarizes the warrant activity since December 31, 2011:

		Number of Warrants

Warrants outstanding at December 31, 2011		8,668,701
Warrants issued		3,523,033
Additional warrants due to anti-dilution provisions		780,930
Warrants exercised during 2012		-
Warrants outstanding at December 31, 2012		12,972,664
Warrants issued		11,570,274
Warrants issued as part of Warrant Exchange Program		138,666
Additional warrants due to anti-dilution provisions		1,665,400
Warrants exercised during 2013		(9,831,414)
Warrants exercised as part of Warrant Exchange Program		(5,862,121)
Warrants outstanding at December 31, 2013		10,653,469

Composition of outstanding warrants:
Warrants containing anti-dilution feature		3,921,381
Warrants with anti-dilution feature removed		6,732,088
		10,653,469

NOTE 11. - RETIREMENT PLAN

The Company sponsors a defined contribution plan under IRC Section 401(k). The plan covers all employees who meet the minimum eligibility requirements. Under the 401(k) plan eligible employees are allowed to made voluntary deferred salary contribution to the plan, subject to statutory limits. The Company has elected to make Safe Harbor Non-elective Contributions to the plan for eligible employees in the amount of three percent ( 3 %) of the employee’s compensation. Total employer contributions to the plan, including a contribution made for 2012 in the first quarter of 2013, amounted to $ 34,873 for the year ended December 31, 2013. There were no employer contributions to the plan for the year ended December 31, 2012.

NOTE 12. - COMMITMENTS

License Agreements - Under its exclusive license agreement with North Carolina State University (“NCSU”), the Company is required to pay minimum annual royalty payments, which are credited against running royalties on sales of licensed products. The annual minimum royalty for 2013 is $ 75,000 , and in 2016 the annual minimum royalty increases to $ 225,000 . The license agreement continues through the life of the last-to-expire patent, which is expected to be 2022. The agreement also requires a milestone payment of $ 150,000 upon FDA approval or clearance of a product that uses the NCSU licensed technology. The Company is also responsible for reimbursing NCSU for actual third-party patent costs incurred. These costs vary from year to year and the Company has certain rights to direct the activities that result in these costs. During the year ended December 31, 2013, the costs incurred related to patent costs and patent maintenance amounted to $ 101,902 ($ 104,558 during the year ended December 31, 2012).

The Company has two other exclusive license agreements which require aggregate annual license fees of approximately $ 75,000 , which are credited against running royalties on sales of licensed products. Each license agreement continues through the life of the last-to-expire patent.

Membership Interest Purchase Agreement – On September 17, 2013, the Company entered into a Membership Interest Purchase Agreement (“ Purchase Agreement”) to purchase all of the issued and outstanding membership interests of NASCO Products, LLC, (“NASCO”), a North Carolina limited liability company (the “NASCO Transaction”). NASCO is a federally licensed tobacco product manufacturer and a participating member of the Tobacco Master Settlement Agreement known as the MSA, an agreement among 46 U.S. states and the tobacco industry administered by the National Association of Attorneys General (“NAAG”).

	F-22

The initial purchase price for the NASCO Transaction is One Million Dollars ($ 1,000,000 ) (the “Purchase Price”), subject to potential closing date adjustments for any unpaid liabilities of NASCO. The Purchase Price will be paid as follows: (i) a cash payment of Two Hundred Thousand ($ 200,000 ) and (ii) the issuance of Eight Hundred Thousand Dollars ($ 800,000 ) in value of unregistered shares of common stock of the Company based on the average of the five (5) day closing price of the Company’s common shares on the OTCBB for the five (5) trading days immediately preceding the closing date. In no event shall the number of common shares issued by the Company to NASCO be less than 640,000 or greater than 1,066,667 .

The Purchase Agreement contains customary representatives, warranties, covenants and indemnities. Consummation of the NASCO Transaction is subject to various conditions, including receipt of material third party consents and approvals and other customary closing conditions, including required consents from NAAG and certain attorneys general of the settling states of the MSA . NAAG has been discussing the NASCO Transaction with a small working group of settling states of the MSA in which the Company has answered various rounds of questions from. The working group has presented the matter to all the settling states with a recommended course of action which is being evaluated by the settling states. Upon the entry of a revised adherence agreement of NASCO Products, LLC reflecting the NASCO Transaction, the Company believes it will be able to close the NASCO Transaction. The Purchase Agreement contains termination rights, including a right for the Company to terminate the Purchase Agreement, solely up to the Company’s discretion, if the closing shall not have occurred on or before January 31, 2014. The Purchase Agreement also contemplates that the Company will enter into a management agreement and sales representation agreement at closing with an affiliate of NASCO.

Lease Agreements - On October 9, 2013, the Company executed a guaranty that guarantees performance by NASCO of its obligations to the landlord under a certain triple net lease of the same date between NASCO and the landlord for a warehouse and cigarette manufacturing facility located in North Carolina. Should the Purchase Agreement close as discussed earlier, NASCO will become a wholly owned subsidiary of the Company, making the lease a direct obligation of the Company. The lease commenced on January 14, 2014, and has an initial term of twelve (12) months (the “Initial Term”). The lease contains four (4) additional extensions; one for an additional one (1) year and three for an additional two (2) years in duration, exercisable at the option of NASCO. The lease also contains an early termination clause that provides NASCO with the right to terminate the lease at any time during the first nine (9) month of the Initial Term by giving ninety (90) days prior written notice to the landlord. The lease calls for minimum lease payments of $ 96,000 , $ 123,000 , $ 298,275 , $ 338,250 and $ 338,250 during the Initial Term, the one (1) year optional extension, and each of the three ( 3 ), two (2) year optional extensions, respectively. These commitments are not included in the schedule below.

The Company entered into a three year lease for office space in Clarence, New York, which commenced September 1, 2011. On January 25, 2013, the Company entered into a two and a half year lease for manufacturing space in Depew, New York, which commenced February 1, 2013. Scheduled rent commitments remaining as of December 31, 2013 are approximately as follows:

2014		$	45,000
2015		$	10,000

Limited Market Make-Good Provision – The Company has a contingent obligation to make whole, through a cash payment, shareholders who exercised the Series C Warrants on August 1, 2013, if the holders incur a loss on the sale of common stock received. (See Note 3 for a detailed discussion).

	F-23

NOTE 13. - EARNINGS PER COMMON SHARE

The following table sets forth the computation of basic and diluted earnings per common share for the year ended December 31, 2013 and 2012:

	December 31,		December 31,
	2013		2012

Net loss attributed to common shareholders	$	(26,153,158)	$	(6,735,281)

Denominator for basic earnings per share-weighted average shares outstanding		43,635,182		30,419,556

Effect of dilutive securities:
Warrants, restricted stock and options outstanding		-		-

Denominator for diluted earnings per common share - weighted average shares adjusted for dilutive securities		43,635,182		30,419,556

Loss per common share - basic	$	(0.60)	$	(0.22)

Loss per common share- diluted	$	(0.60)	$	(0.22)

Securities outstanding that were excluded from the computation of earnings per share for the year ended December 31, 2013 and 2012 because they would have been anti-dilutive are as follows:

	December 31,		December 31,
	2013		2012

Warrants		10,653,469		12,972,664
Convertible Debt Issued December 14, 2011 (number of shares including related warrants upon conversion of 3,061,034)		-		4,706,782
Convertible Debt Issued August 9, 2012 (number of shares including related warrants upon conversion of 371,000)		-		742,000
Restricted Stock		500,000		550,000
Options		660,000		465,000
		11,813,469		19,436,446

NOTE 14. - STOCK BASED COMPENSATION

On October 21, 2010, the Company established the 2010 Equity Incentive Plan (“EIP”) for officers, employees, directors, consultants and advisors to the Company and its affiliates , consisting of 4,250,000 shares of common stock. The EIP has a term of ten years and is administered by our Board of Directors (“Board”) or a committee to be established by our Board (the “Administrator”), to determine the various types of incentive awards that may be granted to recipients under this plan and the number of shares of common stock to underlie each such award under the EIP. On March 30, 2011, the Company filed a Form S-8 registration statement with the SEC to register all of the shares of common stock of 22nd Century Group that it may issue under the EIP.

For year ended December 31, 2013, the Company recorded compensation expense related to restricted stock and stock option awards granted under the EIP of $ 998,214 ($ 732,209 for the year ended December 31, 2012). The Company also recorded stock based compensation for the year ended December 31, 2013, through the issuance of 1,780,000 shares of the Company’s common stock, as payment to third parties for services rendered in the amount of $ 1,363,748 ($ 521,962 for the year ended December 31, 2012).

During the year ended December 31, 2013, the Company issued restricted stock awards from the EIP for 890,000 restricted shares to employees and directors that vested immediately on February 25, 2013 and for 100,000 restricted shares that will vest one year from the April 1, 2013 grant date. Further, 150,000 shares of a restricted stock award previously granted from the EIP vested during the period. All awards were valued at the closing price on the measurement date of the award.

	F-24

As of December 31, 2013, unrecognized compensation expense related to non-vested restricted shares and stock options amounted to approximately $ 100,000 , which is expected to be recognized over the next two years.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The following assumptions were used for the years ended December 31, 2013 and 2012:

	2013		2012
Risk-free interest rate	1.89	%	1.71	%
Expected dividend yield	0	%	0	%
Expected stock price volatility	90	%	90	%
Expected life of options	10 years		10 years

The Company estimated the expected volatility based on data used by peer group of public companies. The expected term was estimated using the contract life of the option. The risk-free interest rate assumption was determined using yield of the equivalent U.S. Treasury bonds over the expected term. The Company has never paid any cash dividends and does not anticipate paying any cash dividends in the foreseeable future. Therefore, the Company assumed an expected dividend yield of zero.

A summary of all stock option activity since December 31, 2011 is as follows:

				Weighted
			Weighted	Average
	Number		Average	Remaining		Aggregate
	of		Exercise	Contractual		Intrinsic
	Options		Price	Term		Value

Outstanding at December 31, 2011	35,000	$	1.20
Granted in 2012	455,000	$	0.65
Forfeited in 2012	(25,000)	$	0.69
Outstanding at December 31, 2012	465,000	$	0.69
Granted in 2013	215,000	$	0.80
Exercised in 2013	(20,000)	$	0.26
Outstanding at December 31, 2013	660,000	$	0.74	8.6 years	$	923,500

Exercisable at December 31, 2013	660,000	$	0.74	8.6 years	$	923,500

The weighted average grant date fair value of options issued in 2013 was $ 0.68 ($ 0.56 – 2012). The total fair value of option that vested during 2013 amounted to $ 186,959 ($ 242,160 – 2011). During the year ended December 31, 2013, 20,000 options were exercised for cash proceeds of $ 5,200 . No options were exercised during the year ended December 31, 2012.

NOTE 15. - INCOME TAXES

The following is a summary of the components giving rise to the income tax provision (benefit) for the years ended December 31, 2013 and 2012.

The provision (benefit) for income taxes consists of the following:

		2013		2012

Current:
Federal	$	-	$	-
State		-		-
Total current		-		-

Deferred:
Federal		829,306		(1,370,382)
State		186,414		(308,039)
Total deferred		1,015,720		(1,678,421)
Change in valuation allowance		(1,015,720)		1,678,421
	$	-	$	-

	F-25

The provision (benefit) for income tax varies from that which would be expected based on applying the statutory federal rate to pre-tax accounting loss as follows:

	2013		2012

Statutory federal rate	(34.0)	%	(34.0)	%
Permanent items	1.8		2.0
Derivative liability	35.5		10.1
State tax provision, net of federal benefit	0.5		(3.0)
Valuation allowance	(3.9)		24.9

Effective tax rate (benefit) provision	0.0	%	0.0	%

Individual components of deferred taxes consist of the following:

		2013		2012

Deferred tax assets:
Net operating loss carry-forward	$	2,616,624	$	3,694,817
Derivative liability		21,725		21,725
Inventory reserve		19,584		69,120
Stock-based compensation		131,450		-
Other		1,292		967
		2,790,675		3,776,629
Deferred tax liabilities:
Inventory		(52,445)		-
Fixed assets		(2,956)		(2,333)
Patents and trademarks		(523,157)		(490,882)
Stock-based compensation		-		(28,300)
Beneficial conversion feature of convertible debt		-		(27,277)
		(578,558)		(548,792)
Valuation allowance		(2,212,117)		(3,227,837)

Net deferred taxes	$	-	$	-

The Company has incurred a net operating loss of approximately $ 6,800,000 through December 31, 2013 and this amount is being carried forward to future years and expires in 2031 and 2032. Due to the uncertainty of the Company’s ability to generate sufficient taxable income in the future before they expire, the company has recorded a valuation allowance to reduce the net deferred tax asset to zero. This NOL is included in the net deferred tax asset that has been fully offset by the valuation allowance.

ASC 740 provides guidance on the financial statement recognition and measurement for uncertain income tax positions that are taken or expected to be taken in a company’s income tax return. The Company has no uncertain tax positions as of December 31, 2013.

	F-26

NOTE 16. - SUBSEQUENT EVENTS

Effective January 27, 2014, the Company’s board of directors awarded officers, employees and directors an aggregate of 850,000 restricted shares that vest one year from the effective date.

	F-27

Item 15 (b) Exhibits

In reviewing the agreements included as exhibits to this report, please remember they are included to provide you with information regarding their terms and are not intended to provide any other factual or disclosure information about the Company, its subsidiaries or other parties to the agreements. The agreements contain representations and warranties by each of the parties to the applicable agreement. These representations and warranties have been made solely for the benefit of the other parties to the applicable agreement and:

should not in all instances be treated as categorical statements of fact, but rather as a way of allocating the risk to one of the parties if those statements prove to be inaccurate;

· have been qualified by disclosures that were made to the other party in connection with the negotiation of the applicable agreement, which disclosures are not necessarily reflected in the agreement;

may apply standards of materiality in a way that is different from what may be viewed as material to you or other investors; and

· were made only as of the date of the applicable agreement or such other date or dates as may be specified in the agreement and are subject to more recent developments.

Accordingly, these representations and warranties may not describe the actual state of affairs as of the date they were made or at any other time. We acknowledge that, notwithstanding the inclusion of the foregoing cautionary statements, we are responsible for considering whether additional specific disclosures of material information regarding material contractual provisions are required to make the statements in this report not misleading. Additional information about the Company may be found elsewhere in this report and the Company’s other public files, which are available without charge through the SEC’s website at http://www.sec.gov.

Exhibit No.		Description

2.1		Agreement and Plan of Merger and Reorganization dated as of January 25, 2011 by and among the Company, 22nd Century, and Acquisition Sub (incorporated herein by reference to Exhibit 2.1 of the Company’s Current Report on Form 8-K filed with the Commission on February 1, 2011).

3.1		Amended and Restated Certificate of Incorporation of the Company (incorporated herein by reference to Exhibit 3.2 of the Company’s Annual Report on Form 10-K for the year ended September 30, 2010 filed with the Commission on December 3, 2010).

3.2*		Amended and Restated Bylaws of the Company.

4.1		Form of Warrant dated as of January 25, 2011 issued to LLC members of 22nd Century prior to the consummation of the Private Placement Offering upon consummation of the Merger (incorporated herein by reference to Exhibit 10.4 of the Company’s Current Report on Form 8-K filed with the Commission on February 1, 2011).

4.2		Form of Warrant dated as of January 25, 2011 issued to investors in the Private Placement Offering upon consummation of the Merger (Incorporated herein by reference to Exhibit 10.5 of the Company’s Current Report on Form 8-K filed with the Commission on February 1, 2011).

4.3		Form of Warrant dated as of January 25, 2011 issued to the Placement Agent and Sub-Agent upon consummation of the Merger (incorporated herein by reference to Exhibit 10.6 of the Company’s Current Report on Form 8-K filed with the Commission on February 1, 2011).

4.4		Advisor Warrant dated as of January 25, 2011 issued to the Placement Agent in connection with that certain Advisory Agreement dated as of January 25, 2011 by and between the Company and the Placement Agent (incorporated herein by reference to Exhibit 10.7 of the Company’s Current Report on Form 8-K filed with the Commission on February 1, 2011).

	45

4.5		Form of Common Stock Purchase Warrant (incorporated herein by reference to Exhibit 4.2 of the Company’s Current Report on Form 8-K filed with the Commission on December 14, 2011).

4.6		Form of Common Stock Purchase Warrant (incorporated herein by reference to Exhibit 4.1 of the Company’s Current Report on Form 8-K filed with the Commission on May 18, 2012).

4.7		Form of Common Stock Purchase Warrant (incorporated herein by reference to Exhibit 4.1 of the Company’s Current Report on Form 8-K filed with the Commission on November 13, 2012).

10.1		2010 Equity Incentive Plan (incorporated herein by reference to Exhibit 4.3 to the Company’s Form S-8 filed with the SEC on March 30, 2011).

10.2†		Employment Agreement dated as of January 25, 2011 by and between the Company and Joseph Pandolfino (incorporated herein by reference to Exhibit 10.15 of the Company’s Current Report on Form 8-K filed with the Commission on February 1, 2011).

10.3†		Employment Agreement dated as of January 25, 2011 by and between the Company and Henry Sicignano III (incorporated herein by reference to Exhibit 10.16 of the Company’s Current Report on Form 8-K filed with the Commission on February 1, 2011).

10.4†		Employment Agreement dated as of March 15, 2011 by and between the Company and Michael R. Moynihan (incorporated by reference to Exhibit 10.18 to the Company’s Form S-1 registration statement filed with the Commission on June 6, 2011).

10.5†††		License Agreement dated March 6, 2009 between North Carolina State University and 22nd Century Limited, LLC (incorporated by reference to Exhibit 10.21 to the Company’s Form S-1 registration statement filed with the Commission on August 26, 2011).

10.5.1		Amendment dated August 9, 2012 to License Agreement dated March 6, 2009 between North Carolina State University and 22nd Century Limited, LLC (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Commission on August 20, 2012).

10.6†††		License Agreement dated May 1, 2009 between The National Research Council of Canada and 22nd Century Limited, LLC (incorporated by reference to Exhibit 10.22 to the Company’s Form S-1 registration statement filed with the Commission on August 26, 2011).

10.7		Letter Agreement between the Company and NCSU dated November 22, 2011 (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed with the Commission on November 23, 2011).
10.8†		Employment Agreement between John Brodfuehrer and the Company dated March 19, 2013 (incorporated by reference to Form 8-K filed on March 25, 2013).
10.9†		Form of Restricted Stock Award Agreement (incorporated by reference to Form 10-Q filed on May 10, 2013).
10.10†		Form of Stock Option Award Agreement (incorporated by reference to Form 10-Q filed on May 10, 2013).
10.11		Agreement dated August 1, 2013 between the Company and the holders of the Company’s Series A and C Warrants (incorporated by reference to Form 10-Q filed on August 5, 2013).
10.12††*		Research License and Commercial Option Agreement with British American Tobacco (Investments) Limited dated October 1, 2013.
10.13		Membership Interest Purchase Agreement between 22nd Century Group, Inc. and Ralph Angiuoli dated September 17, 2013 (incorporated by reference to Form 8-K filed on September 17, 2013).

	46

21.1*		Subsidiaries

23.1*		Consent of Freed Maxick CPAs, P.C.

31.1*		CEO Certification

31.2*		CFO Certification

32.1*		Written Statement of CEO and CFO pursuant to 18.U.S.C §1350

101*		Interactive data files formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Cash Flows, and (iv) the Notes to the Consolidated Financial Statements.

101.INS		XBRL Instance Document*

101.SCH		XBRL Taxonomy Extension Schema Document*

101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document*

101.DEF		XBRL Taxonomy Extension Definition Linkbase Document*

101.LAB		XBRL Taxonomy Extension Label Linkbase Document*

101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document*

*Filed herewith.

† Management contract or compensatory plan, contract or arrangement.

†† Certain portions of the exhibit have been omitted pursuant to a request for confidential treatment. An unredacted copy of the exhibit has been filed separately with the United States Securities and Exchange Commission pursuant to the request for confidential treatment.

††† Certain portions of the exhibit have been omitted pursuant to a confidential treatment order. An unredacted copy of the exhibit has been filed separately with the United States Securities and Exchange Commission pursuant to the request for confidential treatment.

	47

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

			22 nd Century Group, INC.

Date:	January 30, 2014	By:	/s/ Joseph Pandolfino
			Joseph Pandolfino
			Chief Executive Officer and Director
			(Principal Executive Officer)


Date:	January 30, 2014	By:	/s/ John T. Brodfuehrer
			John T. Brodfuehrer
			Chief Financial Officer
			(Principal Accounting and Financial Officer)

Date:	January 30, 2014	By:	/s/ Joseph Pandolfino
			Joseph Pandolfino
			Chief Executive Officer and Director

Date:	January 30, 2014	By:	/s/ Henry Sicignano III
			Henry Sicignano III
			President, Secretary and Director

Date:	January 30, 2014	By:	/s/ Joseph Alexander Dunn, Ph.D.
			Joseph Alexander Dunn, Ph.D.
			Director

Date:	January 30, 2014	By:	/s/ James W. Cornell
			James W. Cornell
			Director

Date:	January 30, 2014	By:	/s/ Richard M. Sanders
			Richard M. Sanders
			Director

	48

AMENDED AND RESTATED BYLAWS
OF
22ND CENTURY GROUP, INC.

(Effective January 28, 2014)

Article I. Offices

Section 1.01 Offices. 22nd Century Group, Inc. (the “Corporation”) may have offices at such places both within and outside the State of Nevada as the Corporation’s Board of Directors (or “Board”) may from time to time determine or the business of the Corporation may require.

Article II. Meetings of Stockholders

Section 2.01 Place of Meetings. All meetings of the stockholders shall be held at any place within or outside the State of Nevada as shall be designated from time to time by the Board of Directors. In the absence of any such designation, stockholders’ meetings shall be held at the principal executive office of the Corporation.

Section 2.02 Annual Meetings. The annual meeting of stockholders shall be held on such date and at such time and place as may be fixed by the Board of Directors and stated in the notice of the meeting, for the purpose of electing directors and for the transaction of such other business as is properly brought before the meeting in accordance with these Bylaws.

To be properly brought before the annual meeting, business must be either (i) specified in the notice of annual meeting (or any supplement or amendment thereto) given by or at the direction of the Board of Directors, (ii) otherwise brought before the annual meeting by or at the direction of the Board of Directors, or (iii) otherwise properly brought before the annual meeting by a stockholder. In addition to any other applicable requirements, for business to be properly brought before an annual meeting by a stockholder, the stockholder must have given timely notice thereof in writing to the Secretary of the Corporation. To be timely, a stockholder’s notice must be delivered to the Secretary at the principal executive offices of the Corporation not later than the close of business on the ninetieth (90 ^th ) day nor earlier than the close of business on the one hundred twentieth (120 ^th ) day prior to the first anniversary of the preceding year’s annual meeting; provided, however, that in the event that the date of the annual meeting is more than thirty (30) days before or more than seventy (70) days after such anniversary date, notice by the stockholder must be so delivered not earlier than the close of business on the one hundred twentieth (120 ^th ) day prior to such annual meeting and not later than the close of business on the later of the ninetieth (90 ^th ) day prior to such annual meeting or the tenth (10 ^th ) day following the day on which public announcement of the date of such meeting is first made by the Corporation. In no event shall the public announcement of an adjournment or postponement of an annual meeting commence a new time period for the giving of a stockholder’s notice as described above.

A stockholder’s notice to the Secretary shall set forth (i) a brief description of the business desired to be brought before the annual meeting and the reasons for conducting such business at the annual meeting, (ii) the name and record address of the stockholder proposing such business, (iii) the class, series and number of shares of the Corporation which are beneficially owned by the stockholder, and (iv) any material interest of the stockholder in such business. Notwithstanding anything in the Bylaws to the contrary, no business shall be conducted at the annual meeting except in accordance with the procedures set forth in this Section 2.02. The officer of the Corporation presiding at an annual meeting shall, if the facts warrant, determine and declare to the annual meeting that business was not properly brought before the annual meeting in accordance with the provisions of this Section 2.02, and if he should so determine, he shall so declare to the annual meeting and any such business not properly brought before the meeting shall not be transacted. Written notice of the annual meeting stating the place, date and hour of the annual meeting shall be given to each stockholder entitled to vote at such meeting not less than ten (10) nor more than sixty (60) days before the date of the meeting.

Section 2.03 Quorum. The holders of one-third (33.33%) of the voting power of the Corporation’s stock at any meeting of stockholders, which are present in person or represented by proxy, shall constitute a quorum for the transaction of business except as otherwise provided by law, by the Articles of Incorporation, or by these Bylaws. A quorum, once established, shall not be broken by the withdrawal of enough votes to leave less than a quorum and the votes present may continue to transact business until adjournment. If, however, such quorum shall not be present or represented at any meeting of the stockholders, a majority of the voting stock represented in person or by proxy may adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present or represented. At such adjourned meeting at which a quorum shall be present or represented, any business may be transacted which might have been transacted at the meeting as originally notified. If the adjournment is for more than thirty (30) days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each stockholder of record entitled to vote thereat.

Section 2.04 Voting. When a quorum is present at any meeting, action of the stockholders on a matter other than the election of directors is approved if the number of votes cast in favor of the action exceeds the number of votes cast in opposition to the action, unless the question is one upon which by express provision of the statutes, or the Articles of Incorporation, or these Bylaws, a different vote is required in which case such express provision shall govern and control the decision of such question. Directors shall be elected by a plurality of the votes cast by the stockholders.

Section 2.05 Proxies. At each meeting of the stockholders, each stockholder having the right to vote may vote in person or may authorize another person or persons to act for him by proxy appointed in a reasonable manner as may be permitted by law, including, without limitation, a signed writing, telegram, facsimile, and electronic communication. All proxies must be filed with the Secretary of the Corporation at the beginning of each meeting in order to be counted in any vote at the meeting. Each stockholder shall have one vote for each share of stock having voting power, registered in his name on the books of the Corporation on the record date set by the Board of Directors as provided in Section 5.06 hereof.

Section 2.06 Special Meetings. Special meetings of the stockholders, for any purpose or purposes, unless otherwise prescribed by statute or by the Articles of Incorporation, may be called by the Chief Executive Officer and shall be called by the Chief Executive Officer or the Secretary at the request in writing of a majority of the Board of Directors or by the holders of a majority of the shares of voting stock. Such request shall state the purpose or purposes of the proposed meeting. Business transacted at any special meeting of stockholders shall be limited to the purposes stated in the notice. Written notice of a request for a meeting by the holders of a majority of the voting shares shall be accompanied by the name and record address of the stockholders proposing the special meeting, and the class, series and number of shares of the Corporation which are beneficially owned by each stockholder, and a description of any material interest of the stockholder in such business.

Section 2.07 Notice. Whenever stockholders are required or permitted to take any action at a meeting, a written notice of the meeting shall be given which notice shall state the place, date and hour of the meeting and the purpose or purposes for which the meeting is called. The written notice of any meeting shall be given to each stockholder entitled to vote at such meeting not less than ten (10) nor more than sixty (60) days before the date of the meeting. If mailed, notice is given when deposited in the United States mail, postage prepaid, directed to the stockholder at his address as it appears on the records of the Corporation.

Section 2.08 Stockholder List. The officer who has charge of the stock ledger of the Corporation shall prepare and make, at least ten (10) days before every meeting of stockholders, a complete list of the stockholders entitled to vote at the meeting, arranged in alphabetical order, and showing the address of each stockholder and the number of shares registered in the name of each stockholder. Such list shall be open to the examination of any stockholder, for any purpose germane to the meeting, during ordinary business hours, for a period of at least ten (10) days prior to the meeting, either at a place within the city where the meeting is to be held, which place shall be specified in the notice of the meeting, or, if not so specified, at the place where the meeting is to be held. The list shall also be produced and kept at the time and place of the meeting during the whole time thereof, and may be inspected by any stockholder who is present.

Section 2.09 Action by Stockholders. Stockholders of the Corporation may only take action at an annual or special meeting of stockholders. Stockholders may not take action by written consent without a meeting.

Article III. Directors

Section 3.01 General. Subject to any limitations in the laws of the State of Nevada, the Articles of Incorporation or these Bylaws, the number of directors may be changed from time to time by resolutions adopted by the Board of Directors and/or the stockholders. No reduction of the number of directors shall have the effect of removing any director prior to the expiration of his term of office. A director need not be a stockholder of the Corporation. Nominations of persons for election to the Board of Directors of the Corporation at the annual meeting may be made at such meeting by or at the direction of the Board of Directors, by any committee or persons appointed by the Board of Directors or by any stockholder of the Corporation entitled to vote for the election of directors at the meeting who complies with the notice procedures set forth in this Section 3.01. Such nominations by any stockholder shall be made pursuant to timely notice in writing to the Secretary of the Corporation. To be timely, a stockholder’s notice shall be delivered to the Secretary at the principal executive offices of the Corporation not later than the close of business on the ninetieth (90th) day nor earlier than the close of business on the one hundred twentieth (120th) day prior to the first anniversary of the preceding year’s annual meeting; provided, however, that in the event that the date of the annual meeting is more than thirty (30) days before or more than seventy (70) days after such anniversary date, notice by the stockholder must be so delivered not earlier than the close of business on the one hundred twentieth (120th) day prior to such annual meeting and not later than the close of business on the later of the ninetieth (90th) day prior to such annual meeting or the tenth (10th) day following the day on which public announcement of the date of such meeting is first made by the corporation. In no event shall the public announcement of an adjournment or postponement of an annual meeting commence a new time period for the giving of a stockholder’s notice as described above.

Such stockholder’s notice to the Secretary shall set forth (i) as to each person whom the stockholder proposes to nominate for election or reelection as a director, (a) the name, age, business address and residence address of the person, (b) the principal occupation or employment of the person, (c) the class and number of shares of capital stock of the Corporation which are beneficially owned by the person, and (d) any other information relating to the person that is required to be disclosed in solicitations for proxies for election of directors pursuant to the Rules and Regulations of the Securities and Exchange Commission under Section 14 of the Securities Exchange Act of 1934, as amended; and (ii) as to the stockholder giving the notice (a) the name and record address of the stockholder and (b) the class and number of shares of capital stock of the Corporation which are beneficially owned by the stockholder. The Corporation may require any proposed nominee to furnish such other information as may reasonably be required by the Corporation to determine the eligibility of such proposed nominee to serve as a director of the Corporation. No person shall be eligible for election as a director of the Corporation unless nominated in accordance with the procedures set forth herein. The officer of the Corporation presiding at an annual meeting shall, if the facts warrant, determine and declare to the meeting that a nomination was not made in accordance with the foregoing procedure, and if he should so determine, he shall so declare to the meeting and the defective nomination shall be disregarded. The directors shall be elected at the annual meeting of the stockholders, except as provided in Section 3.02, and each director elected shall hold office until his successor is elected and qualified; provided, however, that unless otherwise restricted by the Articles of Incorporation or law, any director or the entire Board of Directors may be removed, either with or without cause, from the Board of Directors at any meeting of stockholders by the holders of two-thirds of the voting power of the Corporation’s stock.

Section 3.02 Vacancies. Vacancies on the Board of Directors by reason of death, resignation, retirement, disability, disqualification, removal from office, or otherwise, and newly created directorships resulting from any increase in the authorized number of directors may be filled by a majority of the directors then in office, although less than a quorum, or by a sole remaining director. The directors so chosen shall hold office until the next annual election of directors and until their successors are duly elected and shall qualify, unless sooner displaced. If there are no directors in office, then an election of directors may be held in the manner provided by statute.

Section 3.03 Authority. The property and business of the Corporation shall be supervised by or under the direction of its Board of Directors. In addition to the powers and authorities by these Bylaws expressly conferred upon them, the Board may exercise powers of the Corporation and do all such lawful acts and things as are not by statute or by the Articles of Incorporation or by these Bylaws directed or required to be exercised or done by the stockholders. The Board of Directors shall, by majority vote, elect or remove a director as the Chairman of the Board of Directors. In the event the same person is both the Chairman of the Board of Directors and the Chief Executive Officer, then the independent members of the Board of Directors shall, by majority vote, elect or remove an independent director as the Lead Director. The Lead Director shall have the right to exercise any of the rights of the Chairman of the Board of Directors, as well as the Lead Director shall preside at any separate meeting of only the independent directors.

Section 3.04 Place of Board Meetings. The directors may hold their meetings and have one or more offices, and keep the books of the Corporation outside of the State of Nevada.

Section 3.05 Regular Meetings. Regular meetings of the Board of Directors may be held without notice at such time and place as shall from time to time be determined by the Board.

Section 3.06 Special Meetings. Special meetings of the Board of Directors may be called by the Chairman of the Board of Directors or the Chief Executive Officer on twenty-four (24) hours’ notice to each director; special meetings shall be called by the Chairman of the Board of Directors, the Chief Executive Officer or the Secretary in like manner and on like notice on the written request of two directors unless the Board consists of only one director; in which case special meetings shall be called by the Chairman of the Board of Directors, the Chief Executive Officer or Secretary in like manner or on like notice on the written request of the sole director.

Section 3.07 Quorum and Voting. At all meetings of the Board of Directors a majority of the authorized number of directors shall be necessary and sufficient to constitute a quorum for the transaction of business, and the vote of a majority of the directors present at any meeting at which there is a quorum, shall be the act of the Board of Directors, except as may be otherwise specifically provided by statute, by the Articles of Incorporation or by these Bylaws. If a quorum shall not be present at any meeting of the Board of Directors the directors present thereat may adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present. If only one director is authorized, such sole director shall constitute a quorum.

Section 3.08 Action Without a Meeting. Unless otherwise restricted by the Articles of Incorporation or these Bylaws, any action required or permitted to be taken at any meeting of the Board of Directors or of any committee thereof may be taken without a meeting, if all members of the Board or committee, as the case may be, consent thereto in writing, and the writing or writings are filed with the minutes of proceedings of the Board or committee.

Section 3.09 Form of Meetings. Unless otherwise restricted by the Articles of Incorporation or these Bylaws, members of the Board of Directors, or any committee designated by the Board of Directors, may participate in a meeting of the Board of Directors, or any committee, by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other, and such participation in a meeting shall constitute presence in person at such meeting.

Section 3.10 Committees. The Board of Directors may, by resolution passed by a majority of the whole Board, designate one or more committees, each such committee to consist of one or more of the directors of the Corporation. The Board may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee. In the absence or disqualification of a member of a committee, the member or members thereof present at any meeting and not disqualified from voting, whether or not he or they constitute a quorum, may unanimously appoint another member of the Board of Directors to act at the meeting in the place of any such absent or disqualified member. Any such committee, to the extent provided in the resolution of the Board of Directors, shall have and may exercise all the powers of the Board of Directors in the management of the business and affairs of the Corporation, and may authorize the seal of the Corporation to be affixed to all papers which may require it; but no such committee shall have the power in reference to amending the Articles of Incorporation (except that a committee may, to the extent authorized in the resolution or resolutions providing for the issuance of shares of stock adopted by the Board of Directors, fix the designations and any of the preferences or rights of such shares relating to dividends, redemption, dissolution, any distribution of assets of the Corporation or the conversion into, or the exchange of such shares for, shares of any other class or classes or any other series of the same or any other class or classes of stock of the Corporation or fix the number of shares of any series of stock or authorize the increase or decrease of the shares of any series), adopting an agreement of merger or consolidation, recommending to the stockholders the sale, lease or exchange of all or substantially all of the Corporation’s property and assets, recommending to the stockholders a dissolution of the Corporation or a revocation of a dissolution, or amending the Bylaws of the Corporation; and, unless the resolution, Bylaws, or the Articles of Incorporation expressly so provide, no such committee shall have the power or authority to declare a dividend to authorize the issuance of stock, or to adopt Articles of Merger.

Section 3.11 Committee Minutes. Each committee shall keep regular minutes of its meetings and report the same to the Board of Directors.

Section 3.12 Director Compensation. Unless otherwise restricted by the Articles of Incorporation or these Bylaws, the Board of Directors shall have the authority to fix the compensation of directors. The directors may be paid their expenses, if any, of attendance at each meeting of the Board of Directors and may be paid a fixed sum for attendance at each meeting of the Board of Directors or a stated salary as director. No such payment shall preclude any director from serving the Corporation in any other capacity and receiving compensation therefor. Members of special or standing committees may be allowed like compensation for attending committee meetings.

Section 3.13 Indemnification.

(a)

The Corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative, except an action by or in the right of the Corporation, by reason of the fact that he is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another Corporation, partnership, joint venture, trust or other enterprise, against expenses, including attorneys’ fees, judgments, fines and amounts paid in settlement actually and reasonably incurred by him in connection with the action, suit or proceeding if he either is not liable pursuant to Nevada Revised Statutes 78.138 or acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, does not, of itself, create a presumption that the person is liable pursuant to Nevada Revised Statutes 78.138 or did not act in good faith and in a manner which he reasonably believed to be in or not opposed to the best interests of the Corporation, and, with respect to any criminal action or proceeding, had reasonable cause to believe that his conduct was unlawful.

(b)

The Corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the Corporation to procure a judgment in its favor by reason of the fact that he is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another Corporation, partnership, joint venture, trust or other enterprise against expenses, including amounts paid in settlement and attorneys’ fees actually and reasonably incurred by him in connection with the defense or settlement of the action or suit if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation. Indemnification shall not be made for any claim, issue or matter as to which such a person has been adjudged by a court of competent jurisdiction, after exhaustion of all appeals therefrom, to be liable to the Corporation or for amounts paid in settlement to the Corporation unless and only to the extent that the court in which such action or suit was brought or other court of competent jurisdiction determines upon application that in view of all the circumstances of the case, the person is fairly and reasonably entitled to indemnity for such expenses as the court deems proper.

(c)

To the extent that a director, officer, employee or agent of the Corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to in paragraphs (a) and (b) immediately above, or in defense of any claim, issue or matter therein, he must be indemnified by the Corporation against expenses, including attorneys’ fees, actually and reasonably incurred by him in connection with the defense.

(d)

Any indemnification under paragraphs (a) and (b) immediately above, unless ordered by a court shall be made by the Corporation only as authorized in the specific case upon a determination that indemnification of the director, officer, employee or agent is proper in the circumstances. The determination shall be made (1) by the holders of a majority of the voting power of the corporation’s stock, (2) by the Board of Directors by majority vote of a quorum consisting of directors who were not parties to the act, suit or proceeding, (3) if a majority vote of a quorum consisting of directors who are not parties to the act, suit or proceeding so order, by independent legal counsel in a written opinion, or (4) if a quorum consisting of directors who were not parties to the act, suit or proceeding cannot be obtained, by independent legal counsel in a written opinion.

(e)

Expenses incurred by an officer or director in defending a civil or criminal action, suit or proceeding may be paid by the Corporation in advance of the final disposition of such action, suit or proceeding upon receipt of an undertaking by or on behalf of such director or officer to repay such amount if it shall ultimately be determined that he is not entitled to be indemnified by the Corporation as authorized in this Section 3.13. Such expenses incurred by other employees of the Corporation and agents may be so paid upon such terms and conditions, if any, as the Board of Directors deems appropriate.

(f)

The indemnification and advancement of expenses authorized in or ordered by a court pursuant to the other paragraphs of this Section 3.13, (i) does not exclude any other rights to which a person seeking indemnification or advancement of expenses may be entitled under any Bylaw, agreement, vote of stockholders or disinterested directors or otherwise, for either an action in his official capacity or an action in another capacity while holding his office except that indemnification, unless ordered by a court pursuant to paragraph (b) or for the advancement of expenses made pursuant to paragraph (e), may not be made to or on behalf of any director or officer if a final adjudication establishes that his acts or omissions involved intentional misconduct, fraud or a knowing violation of the law and was material to the cause of action; and (ii) continues for a person who has ceased to be a director, officer, employee or agent and inures to the benefit of the heirs, executors and administrators of such a person. If a claim for indemnification or payment of expenses under this Section 3.13 is not paid in full within ninety (90) days after a written claim therefor has been received by the Corporation, the claimant may file suit to recover the unpaid amount of such claim and, if successful in whole or in part, shall be entitled to be paid the expense of prosecuting such claim. In any such action the Corporation shall have the burden of proving that the claimant was not entitled to the requested indemnification or payment of expenses under applicable law.

(g)

The Board of Directors may authorize, by a vote of a majority of a quorum of the Board of Directors, the Corporation to purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another Corporation, partnership, joint venture, trust or other enterprise against any liability asserted against him and incurred by him in any such capacity, or arising out of his status as such, whether or not the Corporation would have the power to indemnify him against such liability under the provisions of this Section 3.13.

(h)

The Board of Directors may authorize the Corporation to enter into a contract with any person who is or was a director, officer, employee or agent of the Corporation or is or was serving at the request of the Corporation as a director, officer, employee or agent of another partnership, joint venture, trust or other enterprise providing for indemnification rights equivalent to or, if the Board of Directors so determines, greater than those provided for in this Section 3.13.

(i)

For the purposes of this Section 3.13, references to “the Corporation” shall include, in addition to the resulting Corporation, any constituent Corporation (including any constituent of a constituent) absorbed in a consolidation or merger which, if its separate existence had continued, would have had power and authority to indemnify its directors, officers, and employees or agents, so that any person who is or was a director, officer, employee or agent of such constituent Corporation, or is or was serving at the request of such constituent Corporation as a director, officer, employee or agent of another Corporation, partnership, joint venture, trust or other enterprise, shall stand in the same position under the provisions of this Section with respect to the resulting or surviving Corporation as he would have with respect to such constituent Corporation if its separate existence had continued.

(j)

For purposes of this section, references to “other enterprises” shall include employee benefit plans; references to “fines” shall include any excise taxes assessed on a person with respect to an employee benefit plan; and references to “serving at the request of the Corporation” shall include service as a director, officer, employee or agent of the Corporation which imposes duties on, or involves services by, such director, officer, employee or agent with respect to an employee benefit plan, its participants or beneficiaries; and a person who acted in good faith and in a manner he reasonably believed to be in the interest of the participants and beneficiaries of an employee benefit plan shall be deemed to have acted in a manner “not opposed to the best interests of the Corporation” as referred to in this section.

Article IV. Officers .

Section 4.01 General. The officers of this Corporation shall include a Chief Executive Officer, a President, a Secretary, a Treasurer and such other officers as shall be determined below. The Chief Executive Officer shall be chosen by the Board of Directors and all other officers of this Corporation shall be chosen by the Chief Executive Officer and/or the Board of Directors. The Corporation may also have at the discretion of the Chief Executive Officer and/or the Board of Directors such additional officers as are desired, including one or more Vice Presidents, one or more Assistant Secretaries and Assistant Treasurers, and such other officers as may be appointed in accordance with the provisions of Section 4.03 hereof. In the event there are two or more Vice Presidents, then the Chief Financial Officer shall be designated as Executive Vice President, Senior Vice President, or other similar or dissimilar title. The Chief Executive Officer or a majority of the Board of Directors may, from time to time, determine the order of the rank of the officers of the Corporation other than the Chief Executive Officer, who shall be the most senior executive officer of the Corporation. Any number of offices may be held by the same person, unless the Articles of Incorporation or these Bylaws otherwise provide.

Section 4.02 Selection. The Board of Directors, at its first meeting after each annual meeting of stockholders, shall choose the officers of the Corporation. The Board shall also meet at such other applicable times to choose any other officers of the Corporation as needed, such as but not limited to vacancies or newly created officer positions.

Section 4.03 Appointment. The Chief Executive Officer and/or the Board of Directors may appoint such other officers and agents as it shall deem necessary who shall hold their offices for such terms and shall exercise such powers and perform such duties as shall be determined from time to time by the Board.

Section 4.04 Compensation. The salaries of all officers and agents of the Corporation shall be determined by the Board of Directors.

Section 4.05 Term. The officers of the Corporation shall hold office until their successors are chosen and qualify in their stead. Any officer may be removed at any time by Chief Executive Officer and/or the affirmative vote of a majority of the Board of Directors. If the office of any officer or officers becomes vacant for any reason, the vacancy shall be filled by the appointment by the Chief Executive Officer and/or the affirmative vote of the Board of Directors.

Section 4.06 Chief Executive Officer. The Chief Executive Officer shall, subject to the control of the Board of Directors, have primary supervision, direction and control of the business, officers and other employees of the Corporation. He shall preside at all meetings of the Stockholders and, if there is no Chairman of the Board, at all meetings of the Board of Directors. He shall be an ex-officio member of all committees and shall have the general powers and duties of management usually vested in the office of Chief Executive Officer of corporations, and shall have such other powers and duties as may be prescribed by the Board of Directors or these Bylaws.

Section 4.07 President. In the absence or disability of the Chief Executive Officer, the President shall perform all duties of the Chief Executive Officer, and when so acting shall have all the powers of and be subject to all the restrictions upon the Chief Executive Officer. He shall be an ex-officio member of all committees and shall have the general powers and duties of management usually vested in the office of President of corporations, and shall have such other powers and duties as may be prescribed by the Board of Directors or these Bylaws.

Section 4.08 Vice Presidents. In the absence or disability of the Chief Executive Officer and President, the Vice Presidents (including those designated as Executive Vice President, Senior Vice President, or other similar or dissimilar title) in order of their rank as fixed by the Board of Directors, or if not ranked, the Vice President designated by either the Board of Directors or the Chief Executive Officer, shall perform all the duties of the Chief Executive Officer and President, and when so acting shall have all the powers of and be subject to all the restrictions upon the Chief Executive Officer and/or President, as the case may be. The Vice Presidents shall have such other duties as from time to time may be prescribed for them, respectively, by the Board of Directors.

Section 4.09 Secretary. The Secretary shall attend all sessions of the Board of Directors and all meetings of the stockholders and record all votes and the minutes of all proceedings in a book to be kept for that purpose; and shall perform like duties for the standing committees when required by the Board of Directors. The Secretary shall give, or cause to be given, notice of all meetings of the stockholders and of the Board of Directors, and shall perform such other duties as may be prescribed by the Board of Directors or these Bylaws. The Secretary shall keep in safe custody the seal of the Corporation, and affix the same to any instrument requiring it, and when so affixed it shall be attested by his signature or by the signature of an Assistant Secretary. The Board of Directors may give general authority to any other officer to affix the seal of the Corporation and to attest the affixing by his signature.

Section 4.10 Assistant Secretary. The Assistant Secretary, or if there be more than one, the Assistant Secretaries in the order determined by the Board of Directors, or if there be no such determination, the Assistant Secretary designated by the Board of Directors, shall, in the absence or disability of the Secretary perform the duties and exercise the powers of the Secretary and shall perform such other duties and have such other powers as the Board of Directors may from time to time prescribe.

Section 4.11 Treasurer. The Treasurer shall have the custody of the corporate funds and securities and shall keep full and accurate accounts of receipts and disbursements in books belonging to the Corporation and shall deposit all moneys, and other valuable effects in the name and to the credit of the Corporation, in such depositories as may be designated by the Board of Directors. He shall disburse the funds of the Corporation as may be ordered by the Board of Directors, taking proper vouchers for such disbursements, and shall render to the Board of Directors, at its regular meetings, or when the Board of Directors so requires, an account of all his transactions as Treasurer and of the financial condition of the Corporation. If required by the Board of Directors, he shall give the Corporation a bond, in such sum and with such surety or sureties as shall be satisfactory to the Board of Directors, for the faithful performance of the duties of his office and for the restoration to the Corporation, in case of his death, resignation, retirement or removal from office, of all books, papers, vouchers, money and other property of whatever kind in his possession or under his control belonging to the Corporation.

Section 4.12 Assistant Treasurer. The Assistant Treasurer, or if there shall be more than one, the Assistant Treasurers in the order determined by the Board of Directors, or if there be no such determination, the Assistant Treasurer designated by the Board of Directors, shall, in the absence or disability of the Treasurer, perform the duties and exercise the powers of the Treasurer and shall perform such other duties and have such other powers as the Board of Directors may from time to time prescribe.

Article V. Certificates of Stock .

Section 5.01 Certificates. The shares of stock of the Corporation may either be represented by certificates or be uncertificated, as provided in section 78.235 of the Revised Nevada Statutes. Every holder of stock of the Corporation that is represented by a certificate shall be entitled to have a certificate signed by, or in the name of the Corporation by, the Chairman or Vice Chairman of the Board of Directors, or the Chief Executive Officer, President or a Vice President, and by the Secretary or an Assistant Secretary, or the Treasurer or an Assistant Treasurer of the Corporation, certifying the number of shares represented by the certificate owned by such stockholder in the Corporation. Shares of stock of the Corporation may also be evidenced by registration in the holder’s name in uncertificated form and represented by an electronic record on the books of the Corporation in accordance with a Direct Registration System approved by the Securities and Exchange Commission and any securities exchange on which the stock of the Corporation may from time to time be traded.

Section 5.02 Signatures. Any or all of the signatures on the certificate may be a facsimile or other electronic transmission. In case any officer, transfer agent, or registrar who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to be such officer, transfer agent, or registrar before such certificate is issued, it may be issued by the Corporation with the same effect as if he were such officer, transfer agent, or registrar at the date of issue.

Section 5.03 Additional Classes. If the Corporation shall be authorized to issue more than one class of stock or more than one series of any class, the voting powers, designations, preferences, limitations, restrictions and relative rights of each class of stock or series thereof and the qualification, limitations or restrictions of such preferences and/or rights shall be set forth in full or summarized on the face or back of any certificates which the Corporation may issue to represent such class or series of stock, provided that, except as otherwise provided in section 78.195 of the Revised Nevada Statutes, in lieu of the foregoing requirements, there may be set forth on the face or back of any certificates which the Corporation may issue a statement setting forth the office or agency of the Corporation from which the stockholders may obtain a copy of a statement setting forth in full or summarizing the voting powers, designations, preferences, limitations, restrictions and relative rights of each class of stock or series thereof that the Corporation will furnish without charge to each stockholder who so requests. Within a reasonable time after the issuance or transfer of uncertificated stock, the informational statement sent to the holder of such stock shall contain, in addition to the information required by section 78.235 of the Nevada Revised Statutes, a statement setting forth the office or agency of the Corporation from which the stockholders may obtain a copy of a statement setting forth in full or summarizing the voting powers, designations, preferences, limitations, restrictions and relative rights of each class of stock or series thereof that the Corporation will furnish without charge to each stockholder who so requests.

Section 5.04 Replacement Certificates. The Chief Executive Officer, President, or a Vice President designated by the Chief Executive Officer or President may direct a new certificate or certificates or uncertificated shares to be issued in place of any certificate or certificates theretofore issued by the Corporation alleged to have been lost, stolen or destroyed, upon the making of an affidavit of that fact by the person claiming the certificate of stock to be lost, stolen or destroyed. When authorizing such issue of a new certificate or certificates or uncertificated shares, the Board of Directors may, in its discretion and as a condition precedent to the issuance thereof, require the owner of such lost, stolen or destroyed certificate or certificates, or his legal representative, to advertise the same in such manner as it shall require and/or to give the Corporation a bond in such sum as it may direct as indemnity against any claim that may be made against the Corporation with respect to the certificate alleged to have been lost, stolen or destroyed.

Section 5.05 Transfer. Upon surrender to the Corporation, or the transfer agent of the Corporation, of a certificate for shares duly endorsed or accompanied by proper evidence of succession, assignation or authority to transfer, it shall be the duty of the Corporation to issue a new certificate or evidence of the issuance of uncertificated shares to the person entitled thereto, cancel the old certificate and record the transaction upon its books. Nothing in this Section 5.05 shall require the Corporation to issue a new certificate if the Corporation has determined that such shares of stock shall be uncertificated. Uncertificated shares shall be transferable only upon compliance with the customary procedures for transferring shares in uncertificated form recorded electronically on a Direct Registration System.

Section 5.06 Record Date. In order that the Corporation may determine the stockholders entitled to notice of or to vote at any meeting of the stockholders, or any adjournment thereof, or to express consent to corporate action in writing without a meeting, or entitled to receive payment of any dividend or other distribution or allotment of any rights, or entitled to exercise any rights in respect of any change, conversion or exchange of stock or for the purpose of any other lawful action, the Board of Directors may fix a record date which shall not be more than sixty nor less than ten (10) days before the date of such meeting, nor more than sixty (60) days prior to any other action. A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting; provided, however, that the Board of Directors may fix a new record date for the adjourned meeting.

Section 5.07 Record Holders. The Corporation shall be entitled to treat the holder of record of any share or shares of stock as the holder in fact thereof and accordingly shall not be bound to recognize any equitable or other claim or interest in such share on the part of any other person, whether or not it shall have express or other notice thereof, save as expressly provided by the laws of the State of Nevada.

Article VI. General Provisions .

Section 6.01 Distributions. Distributions upon the capital stock of the Corporation, subject to the provisions of the Articles of Incorporation, if any, may be declared by the Board of Directors at any regular or special meeting, pursuant to law.

Section 6.02 Reserves. Before payment of any distribution there may be set aside out of any funds of the Corporation available for distributions such sum or sums as the directors from time to time, in their absolute discretion, think proper as a reserve fund to meet contingencies, or for equalizing distributions, or for repairing or maintaining any property of the Corporation, or for such other purpose as the directors shall think conducive to the interests of the Corporation, and the directors may abolish any such reserve.

Section 6.03 Checks. All checks fund transfers or demands for money and notes of the Corporation shall be signed by the Chief Executive Officer, President or a Vice President designated by the Chief Executive Officer or President, or other officers designated by the Chief Executive Officer or the President.

Section 6.04 Fiscal Year. The fiscal year of the Corporation shall be fixed by resolution of the Board of Directors.

Section 6.05 Corporate Seal. The corporate seal shall have inscribed thereon the name of the Corporation and the words “Corporate Seal, Nevada.” Said seal may be used by causing it or a facsimile thereof to be impressed or affixed or reproduced or otherwise.

Section 6.06 Notice. Whenever, under the provisions of the statutes or of the Articles of Incorporation or of these Bylaws, notice is required to be given to any director or stockholder, it shall not be construed to mean personal notice, but such notice may be given in any manner as may be permitted by law reasonably intended to give actual notice, to such address, physical or electronic, as appears on the records of the Corporation, with any required postage prepaid. Notice to any director may be by any reasonable means, including, without limitation, mail, nationally recognized courier, personal delivery, facsimile, or electronic communication. All notices shall be deemed given when sent.

Section 6.07 Waiver. Whenever any notice is required to be given under the provisions of the statutes or of the Articles of Incorporation or of these Bylaws, a waiver thereof in writing, signed by the person or persons entitled to said notice, whether before or after the time stated therein, shall be deemed equivalent thereto.

Article VII. Amendments .

Section 7.01 Except as otherwise restricted in the Articles of Incorporation or these Bylaws:

(a)

Any provision of these Bylaws may be altered, amended or repealed at the annual or any regular meeting of the Board of Directors without prior notice, or at any special meeting of the Board of Directors if notice of such alteration or repeal be contained in the notice of such special meeting.

(b)

These Bylaws may also be altered, amended or repealed at a duly convened meeting of the stockholders by the affirmative vote of the holders of a majority of the voting power of the Corporation’s stock. The stockholders may provide by resolution that any Bylaw provision repealed, amended, adopted or altered by them may not be repealed, amended, adopted or altered by the Board of Directors.

*****

I, Henry Sicignano, III, hereby certify that the foregoing Amended and Restated Bylaws of 22nd Century Group, Inc., were duly adopted at a meeting of the Board of Directors on January 28, 2014.

	/s/ Henry Sicignano III
	Henry Sicignano, III
	Secretary

[*] = CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

RESEARCH LICENSE AND COMMERCIAL OPTION AGREEMENT

This Research License and Commercial Option Agreement (this “Agreement”) is entered into as of the 1st day of October, 2013 (“Effective Date”) by and among 22nd Century Limited, LLC (“22nd Century”) and 22nd Century Group, Inc. (“22nd Century Group”), each with its corporate headquarters at 9530 Main Street, Clarence, New York 14031, United States of America, and British American Tobacco (Investments) Limited (“BAT”), Reg. No. 00074974, with its registered office at Globe House, 1 Water Street, London WC2R 3LA, United Kingdom.

WHEREAS :

22nd Century has developed and acquired rights to certain materials, technology and intellectual property for use in Nicotiana plants;

BAT desires to obtain from 22nd Century a research license to certain materials, technology and intellectual property of 22nd Century in order to further develop them into commercial products;

BAT desires to obtain from 22nd Century an exclusive option to a license to commercialize such materials, technology and intellectual property rights of 22nd Century; and

22nd Century is willing to grant BAT a research license and an exclusive option for a license on the terms and conditions set forth in this Agreement.

NOW THEREFORE , the Parties agree as follows:

ARTICLE 1 – DEFINITIONS

For the purposes of this Agreement, the terms and phrases below have the following definitions:

1.01 “22nd Century Affiliate” means individually, and “22nd Century Affiliates” means collectively, any corporation, company or other entity in which 22nd Century Group owns or controls, directly or indirectly, at least fifty one percent (51%) of the voting securities.

1.02 “22nd Century Product Affiliate” means individually, and “22nd Century Product Affiliates” means collectively, any corporation, company or other entity in which 22nd Century Group owns or controls, directly or indirectly, at least fifty one percent (51%) of the voting securities and no Competitor Party owns any of the voting securities.

1.03 “22nd Century Product” means any product that 22nd Century or any 22nd Century Product Affiliate imports, exports, distributes, markets, sells or offers to sell that is branded with the wholly-owned marks of 22nd Century or any 22nd Century Product Affiliate, but in no event any product imported, exported, distributed, marketed, sold or offered under any brand or mark of any other individual, entity, association, group, or other person(s) of any kind.

[*] = CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

1.04 “Affiliate” or “Affiliates” means, with respect to any entity other than a 22nd Century Affiliate, BAT Affiliate, or Reynolds Affiliate, any corporation, company or other entity which directly or indirectly controls, is controlled by, or is under common control with such entity. “Control” of an entity shall mean possession, directly or indirectly, of power to direct or cause the direction of management or policies of such entity, whether through ownership of voting securities, by contract, or otherwise.

1.05 “Article” means any of the numbered Articles of this Agreement.

1.06 “BAT Affiliate” means individually, and “BAT Affiliates” means collectively, any corporation, company or other entity in which British American Tobacco plc owns or controls, directly or indirectly, at least thirty percent (30%) of the voting securities, and shall include, without limitation, those set forth in APPENDIX A .

1.07 “Commercial License Commencement” has the meaning set forth in Section 3.02.

1.08 “Commencement Date” means the date that is the forty-fifth (45th) calendar day immediately following the Effective Date.

1.09 “Competitor Party” means the following [*].

1.10 “Field of Use” means any and all use of Nicotiana plants or parts thereof and tobacco and products produced therefrom, including, without limitation, cigarettes, heat-not-burn cigarettes, electronic cigarettes, cigars, tobacco for smoking in pipes or by other means, all forms of smokeless tobacco (such as snus, chewing tobacco, snuff and tobacco dissolvables), and nicotine products. Field of Use shall, however, exclude solely: (i) products (other than combustible cigarettes and cigars, electronic cigarettes and heat-not-burn products) produced from tobacco biomass, including, without limitation, plant proteins, pharmaceutical products other than nicotine products, nutritional products, food and feed ingredients, and biofuels; and (ii) solely in the United States of America, a combustible cigarette product that has been approved for smoking cessation by the Center for Drug Evaluation and Research (CDER) of the U.S. Food and Drug Administration and is intended and offered for smoking cessation. For the avoidance of doubt, the carve out in (ii) above shall not encompass products which may have been approved as a reduced risk product by the U.S. Food and Drug Administration or any other U.S. regulatory body.

1.11 “Full Term” has the meaning set forth in the Commercial License Agreement (as defined in Section 3.01 of this Agreement).

1.12 “Licensed Intellectual Property Rights” means individually any, and collectively all, of the following:

(i)

all of the Patent Rights;

(ii)

all of the Plant Variety Rights;

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(iii) all know-how, copyrights, and/or trade secrets related to the Patent Rights that are owned, co-owned, or licensed (with the right to sublicense) by 22nd Century or any 22nd Century Affiliate as of the Commencement Date; and

(iv) all know-how, copyrights, and/or trade secrets related to the Patent Rights that are:

(aa) acquired by ownership or co-ownership or licensed (with the right to sublicense) at any time after the Commencement Date by 22nd Century or a 22nd Century Affiliate, and

(bb) disclosed to BAT pursuant to this Agreement by or on behalf of 22nd Century or any 22nd Century Affiliate,

except solely for any such know-how, copyrights, and/or trade secrets that are subject to a third party restriction if 22nd Century delivers to BAT, within thirty (30) calendar days after such disclosure, a written notice of non-inclusion that specifically identifies such know-how, copyrights, and/or trade secret and such third party restriction imposed thereon, in which case such know-how, copyrights, and/or trade secrets shall not be included as “Licensed Intellectual Property Rights” unless mutually agreed in writing by the Parties.

1.13 “Licensed Product(s)” means any materials, products or parts thereof, including without limitation any plants, harvested plant parts, seeds, cell lines, strains, genes, DNA, nucleic acid sequences and/or other tangible biological materials, which:

(a) are covered, in whole or in part, by an issued, unexpired claim or pending claim contained in the Patent Rights in any country;

(b) use a process, are manufactured by using a process, or are employed to practice a process which is covered, in whole or in part, by an issued, unexpired claim or pending claim contained in the Patent Rights in any country;

(d) are covered, in whole or in part, by any Plant Variety Rights in any country in which any such material, product or part thereof is grown, made, used, sold, imported, exported or transferred.

1.14 “Non-Patent Rights” means, collectively, any and all copyrights, mask work rights, and similar rights, and registrations, and applications for registration, thereof, and any and all rights of or protecting trade secrets, know-how, computer programs, algorithms, databases, and data, and any and all other intellectual, industrial, or proprietary rights, known or recognized now or in the future.

1.15 “Option” has the meaning set forth in Section 3.01.

1.16 “Party” means, individually, 22nd Century or BAT, as the case may be, and also 22nd Century Group with regard to Section 14.01 and Article 17.

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[*] = CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

1.17 “Parties” means, collectively, 22nd Century and BAT, and also 22nd Century Group with regard to Section 14.01 and Article 17.

1.18 “Patent Rights” means, collectively, all of the following (a) each of the patents and patent applications listed in Appendix B ; (b) any and all applications claiming the benefit of the filing date or claiming priority for any of the foregoing patent applications, including without limitation any divisional applications, continuation applications, continuation-in-part applications, reissue applications, reexaminations and extensions, and any foreign corresponding or counterpart international, regional and national applications; and (c) any and all patents issuing or reissuing from any of the foregoing patent applications.

1.19 “Permitted Researcher” means any of the following entities, but only if and after such entity has entered into a Permitted Researcher Agreement with 22nd Century or a 22nd Century Affiliate and only while such Permitted Researcher Agreement is in effect: (i) an academic institution, or (ii) an entity that does not, and none of whose Affiliates, in any way, directly or indirectly, manufacture, offer for sale, distribute, and/or sell tobacco or tobacco products, and the research conducted by such entity is under the direction, funding or control of 22nd Century or a 22nd Century Affiliate. The term “Permitted Researcher” shall include, without limitation, [*].

1.20 “Permitted Researcher Agreement” means a legally binding written agreement entered into and signed by 22nd Century or a 22nd Century Affiliate with an entity that (other than the execution of a Permitted Researcher Agreement) qualifies as a Permitted Researcher and includes:

(i)

confidentiality obligations which are either:

(aa)

no less rigorous than the confidentiality obligations of the Parties under this Agreement, or,

(bb)

if such Permitted Researcher is an educational institution that does not agree to such confidentiality obligations, less rigorous confidentiality obligations that are nevertheless subject to a requirement that such educational institution shall not:

(A)

disclose to any third party without prior written authorization of 22nd Century or such 22nd Century Affiliate (which authorization 22nd Century or a 22nd Century Affiliate shall not give for any entity or person operating commercially in the Field of Use) or

(B)

publically disclose, unless and until such educational institution has provided to 22nd Century or such 22nd Century Affiliate a reasonable advance written notice prior to any such public disclosure and the option for 22nd Century or such 22nd Century Affiliate to take reasonable steps to protect any intellectual property rights therein or related thereto,

any Property related to the Patent Rights delivered, provided, or made available to such Permitted Researcher by 22nd Century or a 22nd Century Affiliate; and

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(ii)

an obligation to assign, transfer, convey or license to 22nd Century all rights, title and interest in any Property resulting from the research conducted by such entity.

1.21 “Plant Variety Rights” or “PVR” means intellectual property in the form of rights granted by applicable law to the breeder of a new variety of plant that give the breeder control over the propagating material or harvested material of a plant variety or the use thereof (such as for example, “Plant Variety Protection,” “PVP Certificates,” “Plant Variety Right Certificates,” and “Plant Breeders’ Rights Certificates,” and any other rights granted by a member state of the International Union for the Protection of New Varieties of Plants (UPOV) to comply with the International Convention for the Protection of New Varieties of Plants (UPOV Convention)), which variety: (i) is a result of the research and development funded by BAT or any BAT Affiliate (no matter who is the plant breeder) and (ii) is covered by the Patent Rights at the time of filing an application for PVR.

1.22 “Property” means, individually and collectively, any invention, development, discovery, creation, work, technology, process, method, reduction to practice, data, code, device, design, application, implementation, concept, practice, or idea, whether novel, original, or new or whether an improvement to, derivative work or derivation from, or amendment or modification to any existing any invention, development, discovery, creation, work, technology, process, method, reduction to practice, data, code, device, design, application, implementation, concept, practice, or idea, and any and all written and other tangible, and any and all electronic, copies, manifestations, and/or reflections thereof.

1.23 “R&D Development Plan” means the research and development plan prepared by BAT and delivered to 22nd Century.

1.24 “Research Term” means the period of time commencing on the Effective Date of this Agreement and ending the earlier of (i) four (4) years after the Effective Date or (ii) the date of the Commercial License Commencement .

1.25 “Research License” has the meaning set forth in Section 2.01.

1.26 “Research Materials” means any plants, harvested plant parts, seeds, cell lines, strains, genes, DNA, nucleic acid sequences and/or other tangible biological materials, but excluding seeds containing BAT commercial germplasm, covered by the Patent Rights and produced during the development of a commercial Licensed Product by or on behalf of BAT or any BAT Affiliates.

1.27 “Research Purposes” means solely for BAT’s and/or any BAT Affiliate’s own research and product development purposes, and does not include the manufacture of commercial products for their sale.

1.28 “Research Results” means, collectively all, and “Research Result” means individually, any Property resulting or arising from or in connection with, or as a result of, any research, development, or other activities under this Agreement related to validation of the patent claims of the Patent Rights.

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1.29 “Reynolds Affiliate” means individually, and “Reynolds Affiliates” means collectively, any corporation, company or other entity in which Reynolds American Inc. owns, directly or indirectly, at least thirty percent (30%) of the voting securities. “Reynolds” means Reynolds American Inc. and/or any Reynolds Affiliate.

1.30 “Section” means any of the numbered sections under any Article.

1.31 “Territory” means the entire world.

1.32 Certain other defined terms have the meanings given them elsewhere in this Agreement.

ARTICLE 2 – RESEARCH LICENSE

2.01 Research License Grant . Subject to the terms and conditions of this Agreement, 22nd Century hereby grants to BAT, and BAT accept from 22nd Century, an exclusive (except solely as provided in Sections 2.05 and 2.06) worldwide license to use, utilize, exercise, and practice, or have any third party subcontracted by BAT pursuant to Section 2.03 or any BAT Affiliate licensed pursuant to Section 2.02 under this Agreement to use, utilize, exercise, and practice, the Patent Rights and the Licensed Intellectual Property Rights for Research Purposes within the Field of Use during the Research Term, including without limitation the right to use, make, grow, import and export Research Materials for Research Purposes (the “Research License”).

2.02 BAT Affiliates . BAT has the unrestricted right to, and may as it decides in its sole discretion, sublicense, and grant the right to sublicense to any BAT Affiliate, BAT’s rights under the Research License to any BAT Affiliate; provided, however, such BAT Affiliates’ activities under such sublicense shall be subject to all the obligations of BAT under this Agreement related thereto (provided that BAT shall be responsible for any and all payments owed or due to 22nd Century by BAT under this Agreement for the actions of such BAT Affiliates). Subject to the subcontracting right under Section 2.03, such sublicense may not include the right to further sublicense or the right to enforce any Patent Rights without the prior written consent of 22nd Century other than any sublicense to any other BAT Affiliate. BAT shall be responsible and liable for the performance of such sublicensed BAT Affiliates insofar as performance is required to or does fulfill any of BAT’s obligations and limitations under this Agreement, including, without limitation, 22nd Century’s rights to the Research Materials, and an activity of such BAT Affiliate that, if such activity had been performed by BAT, would be an activity under this Agreement shall be deemed to be an activity of BAT. All such sublicense agreements shall automatically terminate upon termination of this Agreement other than as a result of BAT exercising the Option.

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[*] = CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

2.03 Subcontracting . BAT and any BAT Affiliate may outsource any research and development and other activities under the Research License, including in particular work relating to the R&D Development Plan, to any third party, which is selected by BAT or a BAT Affiliate in its sole discretion, pursuant to a written contract agreement between such third party and BAT or such BAT Affiliate (“R&D Contract Agreement”). Any R&D Contract Agreement shall be in writing and in compliance with the terms of this Agreement relating to the Research License (provided that no payment shall be owed or due to 22nd Century or a 22nd Century Affiliate under this Agreement by any such subcontractor). [*] BAT shall be responsible and liable for the performance of the contractors and subcontractors of BAT and BAT Affiliates insofar as performance is required to or does fulfill any of BAT’s obligations and limitations under this Agreement, including, without limitation, with regard to any rights of 22nd Century to the Research Materials, and an activity of such contractor or subcontractor that, if such activity had been performed by BAT, would be an activity under this Agreement shall be deemed to be an activity of BAT. All R&D Contract Agreements shall automatically terminate upon termination of this Agreement other than as a result of BAT exercising the Option.

2.04 Limitations . Other than as provided in Sections 2.02 and 2.03, the Research License does not include the right to grant sublicenses or any other right under this Agreement to any other third party without the prior written consent of 22nd Century. During the Research Term, except as permitted under Article 13 of this Agreement, neither Party shall (i) license, sublicense (except as permitted for BAT in this Agreement), grant, offer to sell, assign or otherwise convey any of the Patent Rights in the Field of Use to any third party, (ii) distribute any Research Materials to any third party except for Research Purposes, and then only pursuant to a material transfer agreement, and/or (iii) sell or offer for sale any of the Research Materials to any third party.

2.05 Limited Retention of Rights by 22nd Century .

(a) Notwithstanding any other provision of this Agreement, but subject to the provisions set forth in Section 2.05(b):

(i) 22nd Century and 22nd Century Affiliates shall retain the right to practice the Patent Rights and Licensed Intellectual Property Rights worldwide solely for research purposes (but, in no event, any commercialization) in the Field of Use during the Research Term, but no research or development that benefits directly or indirectly any Competitor Party; provided, however, that nothing in this Section 2.05(a)(i) shall limit 22nd Century’s rights outside the Field of Use and/or 22nd Century’s right to commercialize 22nd Century Products pursuant to Section 2.05(a)(ii); and

(ii) 22nd Century and 22nd Century Product Affiliates shall retain the right in the Field of Use to make, have made, grow, have grown, import, export, distribute, sell, offer to sell, and otherwise engage in commercialization of solely Licensed Products that are 22nd Century Products during the Research Term.

(b) 22nd Century and 22nd Century Affiliates may have any research permitted under Section 2.05(a)(i) performed by a Permitted Researcher only in accordance with, and shall cause such Permitted Researcher to comply with and perform in accordance with, the Permitted Researcher Agreement of such Permitted Researcher. [*]

(c) Other than to 22nd Century Affiliates or to have them exercised by Permitted Researchers under Section 2.05(a) and (b), such limited retained rights under Section 2.05(a) of 22nd Century in the Field of Use may not be extended, sublicensed, assigned, or transferred to any third party in any way.

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(d) 22nd Century shall be responsible and liable for the performance of the 22nd Century Affiliates and the contractors and subcontractors of 22nd Century and 22nd Century Affiliates insofar as performance is required to or does fulfill any of 22nd Century’s obligations and limitations under this Agreement. An activity of such a contractor or subcontractor that, if such activity had been performed by 22nd Century, would be an activity under this Agreement shall be deemed to be an activity of 22nd Century.

2.06 Limited Retention of Rights by NRC . Notwithstanding any other provision of this Agreement, a portion of the rights granted to BAT in this Agreement is subject to certain research rights retained by the National Research Council of Canada and its Plant Biotechnology Institute (the “NRC”) under 22nd Century’s worldwide exclusive in-license agreement with NRC, for NRC to use certain of the Patent Rights identified in Appendix B , solely for research (but not commercial) purposes within NRC, which may include academic collaborations with publicly funded institutions.

2.07 Research Results . BAT or BAT Affiliates shall solely own any and all rights, title, and interest in and to any and all Research Results and Property, and all proprietary rights therein and thereto, arising from or in connection with, or as a result of, any research, development, or other activities by or for BAT or any BAT Affiliate or any research, development, or other activities fully or partially funded by BAT or any BAT Affiliate (no matter who is the inventor, author, or other creator) related to, or that have application in, the Field of Use or otherwise, including, without limitation, any improvements, derivative works, modifications, or enhancements to or of or from or based on any of the Licensed Intellectual Property Rights. 22nd Century shall, and shall cause any 22nd Affiliate or any employee of 22nd Century or a 22nd Century Affiliate to, execute any assignment or other document, and take any other action reasonably requested by BAT to implement and effect the foregoing provisions.

For the avoidance of doubt, during the Research Term

(i)

BAT shall not be required to provide to 22nd Century any seeds containing BAT commercial germplasm; and

(ii)

nothing in this Section 2.07 shall be construed as to grant BAT ownership rights in any Research Results or Property, or any proprietary rights therein or thereto, including without limitation any improvements, modifications, or enhancements covered by the Licensed Intellectual Property Rights, arising from or in connection with, or as a result of,

(aa)

any research, development, or other activities by, or by a third party (other than a BAT Affiliate) for, 22nd Century or any 22nd Century Affiliate, or

(bb)

any research, development, or other activities fully or partially (other than with BAT or a BAT Affiliate) funded by 22nd Century or any 22nd Century Affiliate (no matter who is the inventor, author, or other creator), even if the source of such funding is from any payments made by BAT to 22nd Century pursuant to the terms of this Agreement.

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ARTICLE 3 – EXCLUSIVE OPTION

3.01 Exclusive Option . Subject to the terms and conditions of this Agreement, 22nd Century hereby grants to BAT, and BAT accepts from 22nd Century, a nontransferable option (the “Option”), exercisable only during the Research Term, for BAT to obtain a license to commercialize the Patent Rights and other Licensed Intellectual Property Rights in the Field of Use under the terms and conditions of the Commercial License Agreement attached as Schedule 1 to this Agreement (the “Commercial License Agreement”). The Option shall be exclusive to BAT, and 22nd Century shall not grant, directly or indirectly, to any third party any option, right, license, entitlement, expectation, or other capacity to commercialize, or exercise or practice for any commercial purposes any Licensed Intellectual Property Rights in the Field of Use (except as otherwise provided in Sections 2.05 and 2.06).

3.02 Exercise of Option . The Option may be exercised by BAT at any time during the Research Term upon written notice from BAT to 22nd Century, such notice to include two (2) signature pages of the Commercial License Agreement executed on behalf of BAT (the “Exercise Notice”). If BAT exercises the Option as provided in the first sentence of this Section 3.02 during the Research Term, the Commercial License Agreement shall become, immediately and automatically (without need for any other action), a valid and effective legally binding agreement between BAT and 22nd Century (“Commercial License Commencement”). 22nd Century and 22nd Century Group shall provide BAT with two (2) signature pages of the Commercial License Agreement executed by 22nd Century and 22nd Century Group promptly thereafter, provided that the execution of signature pages by 22nd Century and/or 22nd Century Group shall not be a condition for the Commercial License Agreement becoming or being a valid and effective agreement between BAT and 22nd Century upon BAT’s exercising the Option. The Commercial License Agreement shall be governed solely and shall be effective separately and independently of this Agreement by the provisions, terms, and conditions set forth in the Commercial License Agreement and the provisions, terms, and conditions of this Agreement.

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ARTICLE 4 – RESEARCH AND DEVELOPMENT, REPORTS AND MATERIALS

4.01 Development Plan . BAT shall use its reasonable endeavors to perform the R&D Development Plan work and shall be responsible for funding all R&D Development Plan work undertaken by or for BAT or any BAT Affiliate. The R&D Development Plan shall be finalized by BAT within thirty (30) days from the Effective Date of this Agreement or such longer period as reasonably requested by BAT. For the avoidance of doubt, BAT shall not be obligated to undertake or continue, and may at any time end, any specific research and development activities or pursue or perform any part of the R&D Development Plan if BAT, in its reasonable judgment, determines that such activities or part have no realistic prospect of reasonably achieving, or are unlikely to contribute to the achievement of, a Milestone (as defined in Section 5.02), without terminating or ending any other activities under this Agreement.

4.02 Data Exchange .

(a) Promptly after the Commencement Date and subject to Section 9.03, 22nd Century shall: (i) provide to BAT descriptions of all seed germplasm and seeds in the possession or under the control of 22nd Century or any 22nd Century Affiliate covered by any of the Licensed Intellectual Property Rights as of the Commencement Date and, pursuant to a material transfer agreement in the form attached as Schedule 2 of this Agreement (“Material Transfer Agreement”), provide to BAT samples of any requested seed germplasm and seeds in the possession or under the control of 22nd Century or any 22nd Century Affiliate covered by any of the Licensed Intellectual Property Rights as of the Commencement Date; (ii) pursuant to a Material Transfer Agreement, allow access to any requested germplasm and seeds owned by current or past collaborators with 22nd Century or any 22nd Century Affiliate covered by any the Licensed Intellectual Property Rights as of the Commencement Date; (iii) provide access to BAT to any and all Property in the possession or under the control of 22nd Century or any 22nd Century Affiliate relating to the Licensed Intellectual Property Rights and the related research and development thereof as of the Commencement Date, including allowing reasonable access to all relevant individuals who have been involved in researching and developing the Patent Rights; and (iv) share with BAT all information (and related Property) that 22nd Century has as of the Commencement Date with regard to (aa) all third party intellectual property rights and prior art which relates to the Field of Use, (bb) BAT’s potential freedom to operate regarding the Patent Rights and the commercialization thereof, and (cc) how 22nd Century would propose to commercialize the Patent Rights in the event that they had acquired the rights which BAT has obtained under this Agreement and the Commercial License Agreement.

(b) The Parties agree that the ”Material Transfer Agreement” referred to above shall be for the purposes of: (i) restricting BAT from sharing the seed germplasm and seeds provided to BAT by 22nd Century with any third parties without the prior approval of 22nd Century; and (ii) requiring BAT to return or destroy any such seed germplasm and seeds in the event that the Research License terminates or expires without BAT exercising the Option in accordance with the “Material Transfer Agreement” as attached as Schedule 2 to this Agreement.

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4.03 BAT Progress Meetings . During the Research Term, BAT shall hold quarterly progress meetings with 22nd Century at which: (a) BAT will present (i) BAT’s research goals and research direction regarding the Patent Rights; (ii) an update on what stage BAT is at with regard to satisfying the Milestones; and (iii) any other information BAT decides to share with 22nd Century, and (b) 22nd Century will present BAT with any research and development information or Research Results that 22nd Century decides to share with BAT. The information disclosed at such R&D update meetings shall be disclosed on a confidential basis in accordance with Article 10. If requested by BAT, 22nd Century’s vice president of R&D shall meet with BAT researchers in person no less than twice per year and no more than four times per year, unless otherwise agreed by 22nd Century, at a destination chosen by BAT, including within sixty days of the Effective Date. Prior to the commencement of any progress meeting, or any other meeting, each of the individual participants in such meeting shall complete and sign a copy of the document attached as Schedule 3 to this Agreement so such individual is bound to obligations of confidentiality in accordance with Article 10. Nothing in such document alters, changes, modifies, amends, limits, restricts, or replaces any provision in this Agreement or the Commercial License Agreement.

4.04 Research Materials . During the Research Term, subject to BAT’s ownership thereof and to Article 10 and Section 9.03, BAT shall deliver to, upon request by, 22nd Century a reasonable number of samples of Research Materials created by and/or in the possession or control of BAT or any BAT Affiliate under this Agreement. For the avoidance of doubt, BAT shall not be required to provide to 22nd Century any seeds containing BAT commercial germplasm.

4.05 License to Research Results . BAT hereby grants to 22nd Century a non-exclusive, non-transferable, non-assignable, non-sublicensable, worldwide license to any and all registered Research Results owned by BAT from the Commercial License Commencement, or from the termination or expiration of the Research License in the event that BAT does not exercise the Option, to develop and commercialize 22nd Century Products. Such license shall be effective at 22nd Century’s election in 22nd Century’s sole discretion and shall be on commercially reasonable terms negotiated in good faith, including, without limitation, a limited duration, an arm’s length royalty, performance obligation, and no warranty, representation, covenant, indemnity, or comfort from BAT regarding validity, enforceability, non-infringement, or risk of third party claims regarding infringement or misappropriation relating to such intellectual property rights, but otherwise in no case on terms more onerous than the terms of the Commercial License (as defined in Schedule 1 to this Agreement) granted to BAT under the terms of the Commercial License Agreement attached as Schedule 1 to this Agreement. In the event the Research License expires or terminates without BAT exercising the Option, BAT shall provide 22nd Century with the details of any registered Research Results then in existence to the extent that 22nd Century is not already aware of such Research Results, subject to compliance with Article 10.

ARTICLE 5 – PAYMENTS

5.01 Initial Fee . Within two (2) business days after the execution of this Agreement by 22nd Century and BAT, BAT shall pay to 22nd Century a non-refundable initial fee of seven million dollars ($7,000,000.00) pursuant to the wire transfer instructions provided to BAT by 22nd Century prior to the Effective Date.

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5.02 Milestone Payments . In addition to the initial fee under Section 5.01, BAT agrees to pay 22nd Century, upon completion of each of the performance milestones referenced in paragraphs (a) through (d) below in this Section 5.02, and set forth in a certain letter from BAT to 22nd Century dated as of the Effective Date, during the Research Term (each, a “Milestone”) the payment that is set forth below for such respective performance milestone (the “Milestone Fee”).

(a) A Milestone Fee of one million five hundred thousand dollars ($1,500,000.00) following successful achievement of Milestone 1 (the “First Milestone”);

(b) A Milestone Fee of one million five hundred thousand dollars ($1,500,000.00) following successful achievement of Milestone 2 (the “Second Milestone”);

(c) A Milestone Fee of two million dollars ($2,000,000.00) following successful achievement of Milestone 3 (the “Third Milestone”); and

(d) A Milestone Fee of two million dollars ($2,000,000.00) following achievement of Milestone 4 (the “Fourth Milestone”).

The First Milestone and the Second Milestone are collectively the “Phase I Milestones.” The Third Milestone and the Fourth Milestone are collectively the “Phase II Milestones.” Each Milestone Fee is due and payable by the end of thirty (30) days of BAT’s or any BAT Affiliates achievement of the associated Milestone. Milestone Fees shall not be due and payable after BAT exercises the Option. More precise Milestone details, in order to ensure that they are measureable, have been agreed to by the Parties in a certain letter agreement dated as of the Effective Date.

5.03 Taxes . BAT shall deduct from any Milestone Fee to 22nd Century under this Agreement the appropriate amount of any withholding tax, duty, or other charges imposed under applicable law, and required to be paid under applicable law, to a government on such Milestone Fee payment under this Agreement, provided that BAT shall take reasonable steps within such applicable law to reduce or eliminate any such withholding requirement. In no event shall BAT be liable or responsible for, and 22nd Century shall indemnify and hold harmless BAT, for any amount of any tax assessed or due on any income of 22nd Century from any payment under this Agreement.

5.04 Currency and Interest . All payments made to 22nd Century under this Agreement shall be paid in United States Dollars by wire transfer to a United States Dollar account designated by 22nd Century, consistent with all applicable laws and regulations. Any payment owed and due by a Party to the other Party under this Agreement and not paid to such other Party within thirty (30) days after the date on which such payment became due shall bear interest until payment at a rate of one percent (1%) for each full calendar month. The expiration or termination of this Agreement does not relieve a Party of its financial obligations to the other Party which have accrued and become due hereunder prior to the date of such expiration or termination. Each Party (the “Payor”) may offset or deduct from, or set off against, any payment owed by the Payor to the other Party (the “Payee”) any undisputed amount that the Payee owes to the Payor if and to the extent that such amount is undisputedly owed and due to the Payor under this Agreement. The Payor shall provide the Payee with written notice of the offset, deduction, or set-off (identifying the cause and sum of both the amount owed by the Payee and the payment from which such amount is offset or deducted or against which it is set off) at the time the remaining payment owed by the Payor is made or, if no part of such payment is remaining, at the time such payment would have had to be made. Any such undisputed offset, deduction, or set-off of any amount by the Payor shall satisfy the obligation of the Payor to pay such amount as if such amount had been paid by the Payor to the Payee.

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ARTICLE 6 – TERMINATION

6.01 Termination by BAT; Commercial License Commencement . BAT may terminate this Agreement at any time during the Research Term and at BAT’s sole discretion (without cause) by giving 22nd Century written notice at least thirty (30) days prior to such termination. This Agreement shall automatically terminate and expire upon the Commercial License Commencement. It is understood that BAT will remain responsible for all monetary payments or other obligations which accrued and became due prior to the effective date of termination.

6.02 Termination of Research License . In the event that BAT terminates this Agreement without cause during the Research Term by giving a written notice of termination of this Agreement pursuant to Section 6.01 (the “Termination Notice”), BAT shall have no liability under this Agreement for, as a result of or on the occasion of such termination, and shall have no liability under this Agreement after such termination (except for any liability of BAT under this Agreement for any breach of BAT antecedent to such termination or for any breach of BAT after such termination of any obligation that survives such termination pursuant to Article 20), except as follows:

(a) In the event that BAT so terminates this Agreement by giving the Termination Notice prior to the completion of both of the Phase I Milestones, BAT shall pay to 22nd Century an amount equal to half the Milestone Fee payments that BAT would have made to 22nd Century for the completion of any remaining Phase I Milestones. For the avoidance of doubt, no payment relating to any Milestone shall be due to the extent that: (i) it has been previously completed and paid; or (ii) BAT has previously notified 22nd Century that BAT has decided that there is no reasonable prospect of achieving such Milestone and so has ceased carrying out work related to the achievement of that Milestone.

(b) In the event that BAT so terminates this Agreement by giving the Termination Notice after the completion of the Phase I Milestones, BAT shall pay to 22nd Century an amount equal to half the Milestone Fee payments that BAT would have made to 22nd Century for the completion of any remaining Phase II Milestones. For the avoidance of doubt, no payment relating to any Milestone shall be due to the extent that: (i) it has been previously completed and paid; or (ii) BAT has previously notified 22nd Century that BAT has decided there is no reasonable prospect of achieving such Milestone and so has ceased carrying out work related to the achievement of that Milestone.

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6.03 Notification . Should BAT, at any time during the Research Term, permanently cease conducting the performance of all research or development activities under this Agreement, BAT shall promptly notify 22nd Century and this Agreement will terminate upon such notice. It is understood that BAT will remain responsible for all monetary payments or other obligations which accrued and became due prior to the effective date of termination. For the avoidance of doubt, this Agreement will not terminate as long as BAT continues to perform research and development activities directed to the achievement of at least one Milestone. BAT may cease to conduct activities directed to achievement of one, two, or three Milestones if, in BAT’s reasonable judgment, it determines that the one, two, or three Milestones are not achievable.

6.04 Termination by 22nd Century . Subject to Section 6.05, 22nd Century shall have the right to terminate this Agreement during the Research Term upon the occurrence of one or more of the following events:

(a) failure of BAT to make any payment required pursuant to this Agreement when due;

(b) failure of BAT to render reports to 22nd Century required by this Agreement;

(c) the initiation by BAT of any action that challenges the validity, enforceability or patentability of any Patent Rights (except in response to any action by 22nd Century or any 22nd Century Affiliate against BAT or any BAT Affiliate asserting infringement or breach of such Patent Rights) ;

(d) the material breach by BAT of any other material term of this Agreement.

6.05 Notice of Breach and Right to Cure . In all cases of alleged breach by BAT of this Agreement entitling 22nd Century to terminate this Agreement under Section 6.04, 22nd Century must give BAT sixty (60) days’ prior written notice of such breach including the remedy sought, be it termination of this Agreement or another remedy (“Breach Notice”) . The Breach Notice must also specify the articles and sections of this Agreement which are claimed to have been breached and must contain a description of the event(s) or occurrence(s) claimed to constitute a breach. In all cases, BAT shall have sixty (60) days from the date of receipt of the Breach Notice to cure the alleged breach or in good faith to dispute the existence of a breach. If the claimed breach is cured within sixty (60) days, this Agreement shall not terminate. If BAT fails to cure the alleged breach by BAT within sixty (60) days of the Breach Notice , this Agreement shall terminate upon the expiration of the sixty (60) days, unless BAT initiates arbitration against such termination under this Agreement, in which case the termination of this Agreement or another remedy related thereto will not be effective and will be subject to the following: (i) i f it is decided in a final unappealable or unappealed decision in such arbitration or an appeal thereof in accordance with Section 11.02 that the breach identified in such Breach Notice did not occur or did not entitle 22nd Century to a termination of this Agreement, or that the prerequisites of the termination do not exist, the termination shall be ineffective ab initio , or (ii) if it is decided in a final unappealable or unappealed decision in such arbitration or an appeal thereof in accordance with Section 11.02 that the breach identified in such Breach Notice occurred, that 22nd Century was entitled to the termination of this Agreement for such breach, and that the prerequisites of such termination exist, BAT shall have the right to cure such breach within thirty (30) days of receiving such decision, in which case the termination shall be ineffective, or absent such cure shall become effective at the end of such thirty (30) day period . Any Breach Notice shall not prejudice any Party’s rights and obligations under this Agreement, including without limitation, 22nd Century’s right to receive monetary sums due hereunder.

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ARTICLE 7 – PATENT PROSECUTION

7.01 Patent Prosecution . During the Research Term, 22nd Century shall prosecute and maintain all patents and patent applications of the Patent Rights. 22nd Century shall not abandon any patent application filed or issued patent in the Patent Rights without express prior written approval from BAT. Payment of all fees and costs relating to the filing, prosecution, and maintenance of the Patent Rights are ordinarily the responsibility of 22nd Century. However, 22nd Century shall take any additional lawful prosecution or maintenance activities related to the Patent Rights which BAT may reasonably request from time to time; provided, however, that BAT pays all costs and expense, including all reasonable attorneys’ fees, necessary for such activities.

7.02 Cooperation . BAT and 22nd Century agree to cooperate with each other in filing, prosecution, and maintenance of the Patent Rights. Upon the request of BAT, 22nd Century will provide copies by email to BAT and any agents of BAT of all patent office actions and 22nd Century’s responses to such office actions for the patent applications in Appendix B , plus any other applications that are part of the Patent Rights that may be filed. 22nd Century will give BAT the opportunity to offer comments and remarks thereon at BAT’s expense, such comments and remarks to be given due consideration by 22nd Century. However, notwithstanding anything to the contrary in this Agreement, all decisions with respect to the filing, prosecution, and maintenance of Patent Rights are reserved solely to 22nd Century.

ARTICLE 8 – INFRINGEMENT OF PATENT RIGHTS BY THIRD PARTIES

8.01 Notice of Infringement by Third Parties . Each of the Parties shall inform the other Party promptly in writing of any alleged infringement of which it becomes aware and of any available evidence of infringement by a third party of any patent within the Patent Rights.

8.02 BAT Enforcement Options . If, during the Research Term, BAT becomes aware of any alleged infringement by a third party in the Territory, BAT has the right, but not the obligation, to either:

(a) settle the infringement suit by sub-licensing the alleged infringer (but only in accordance with the provisions of this Agreement and if such settlement has no adverse effect on any consideration to be received by 22nd Century under this Agreement ) or by other means reasonably acceptable to 22nd Century; or

(b) prosecute at its own expense any infringement of the Patent Rights and/or Plant Variety Rights, in which case BAT may, for such purposes, request to use the name of 22nd Century as party plaintiff and 22nd Century shall, upon BAT’s request, join any action and become a party plaintiff, and costs and expenses (including without limitation attorneys’ fees) associated therewith must be borne by BAT.

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8.03 Enforcement by BAT . If BAT undertakes the enforcement and/or defense of the Patent Rights and/or Plant Variety Rights by litigation, including any declaratory judgment action, the total cost of any such action commenced or defended solely by BAT shall be borne by BAT and BAT shall indemnify 22nd Century and any applicable licensor for any counter or cross-claim. Any recovery of damages by BAT as a result of such action will be applied first in satisfaction of any unreimbursed expenses and attorneys’ fees of BAT relating to the action, and second toward reimbursement of 22nd Century’s expenses, including attorneys’ fees, if any, relating to the action. The balance remaining from any such recovery shall be equally split between 22nd Century and BAT. BAT is entitled to settle any such litigation by agreement, consent, judgment, voluntary dismissal, or otherwise, but only with the prior written consent of 22nd Century and if it has no adverse effect on any consideration to be received by 22nd Century under this Agreement .

8.04 Enforcement by 22nd Century. If BAT does not institute legal action against the infringing activity within three (3) months of having been made aware of or notified thereof, 22nd Century has the right, but is not obligated, to prosecute at its own expense any such infringement of the Patent Rights and/or Plant Variety Rights. In furtherance of that right, 22nd Century may use the name of BAT as a party plaintiff in any such action. The total cost of any such infringement action commenced or defended solely by 22nd Century must be borne by 22nd Century. Any recovery by 22nd Century in such action will be applied first in satisfaction of any unreimbursed expenses and attorneys’ fees of 22nd Century relating to the action, and second toward reimbursement of BAT’s expenses, including attorneys’ fees, if any, relating to the action. The balance remaining from any such recovery belongs solely to 22nd Century.

8.05 Cooperation by the Parties . In any infringement suit instituted by either Party to enforce the Patent Rights, the other Party must, at the request and expense of the Party initiating such suit, cooperate in all respects and, to the extent possible, have its employees testify when requested and make available relevant records, papers, information, data, samples, specimens, and the like.

8.06 Invalidity of any of Patent Rights and/or Plant Variety Patents . Any of the foregoing notwithstanding, if, at any time during the Research Term, any of the Patent Rights and/or Plant Variety Rights are held invalid or unenforceable in a decision which is not appealable or is not appealed within the time allowed, BAT does not have a damage claim or a claim for refund or reimbursement against 22nd Century, but if such invalidity or unenforceability is of the last of the Patent Rights, no further Milestone Fees shall be due for any time after such invalidity or unenforceability.

8.07 Freedom to Operate Notice . Each Party to this Agreement will inform the other Party promptly in writing if it becomes aware that the Patent Rights and/or Plant Variety Rights may infringe any third party’s patent rights.

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ARTICLE 9 – REGULATORY APPROVALS, PUBLICATION AND EXPORT

9.01 Laws and Regulations of the U.S. This Agreement is subject to all United States laws and regulations controlling the export of technical data, computer software, laboratory prototypes and other commodities and technology. It is understood that 22nd Century is subject to United States laws and regulations controlling the export of technical data, computer software, laboratory prototypes and other commodities (including the Arms Export Control Act, as amended and the Export Administration Act of 1979).

9.02 Licenses and Authorizations . To the extent any third party or governmental licenses, approvals, or authorizations are required for BAT to use and exploit the Licensed Intellectual Property Rights as envisaged under the terms of this Agreement, it shall be the sole responsibility of BAT to obtain any and all such licenses, approvals, authorizations, technology or intellectual property at BAT’s sole cost and expense. To the extent any third party or governmental licenses, approvals, or authorizations are required for 22nd Century to use and exploit the Licensed Intellectual Property Rights as envisaged under the terms of this Agreement, it shall be the sole responsibility of 22nd Century to obtain any and all such licenses, approvals, authorizations, technology or intellectual property at 22nd Century’s sole cost and expense. Subject to, and without limiting any of, the provisions, rights, or obligations of a Party under this Agreement, neither Party shall be obligated to procure any right under or to any intellectual property right of any third party necessary for the other Party’s use or exploitation of any Licensed Intellectual Property Right.

9.03 Material Exchange . Subject to Section 9.02, the Parties will cooperate in good faith with each other to obtain any and all permits or approvals necessary for the exchange of any materials pursuant to Sections 4.02 and 4.04, respectively.

ARTICLE 10 – CONFIDENTIALITY

10.01 Confidentiality . Each Party will each treat any Property disclosed to it (the “Receiving Party”) by the other Party (the “Disclosing Party”) with reasonable care and will not disclose such information to any other person, firm or corporation, except Affiliates and contractors of the Receiving Party bound by the obligations of confidentiality and restricted use set forth in this Article 10. Any Property the rights to which are owned under this Agreement by a Party shall be the confidential information of such Party, and such Party shall be deemed to be the Disclosing Party of such Property under this Agreement. The Receiving Party may not use the Disclosing Party’s confidential information other than for the benefit of the Parties and in the performance of this Agreement. These obligations of non-disclosure and restricted use remain in effect for each subject disclosure of confidential information while this Agreement is in effect and until the later of the date of termination of this Agreement or five (5) years from the date of disclosure. However, notwithstanding the foregoing, no Receiving Party is obligated, with respect to Property disclosed to it by the Disclosing Party, or any part thereof, which:

(a) is already known to the Receiving Party at the time of the disclosure;

(b) becomes publicly known without the wrongful act or breach of this Agreement by the Receiving Party;

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(d) is subsequently and independently developed by employees or contractors of the Receiving Party who had no knowledge of such Property, as verified by written records;

(e) if and to the extent and only as approved for release by prior written authorization of the Disclosing Party; or

(f) is disclosed pursuant to the requirements of applicable law or pursuant to any judicial or government requirement, regulation or order, including without limitation any securities regulations, provided that the Receiving Party takes reasonable steps to provide the Disclosing Party sufficient prior notice in order to contest such request, requirement or order and provided that such disclosed confidential information otherwise remains subject to the obligations of confidentiality set forth in this Article 10.

10.02 Confidential Disclosures . The Parties agree that any Property to be treated as confidential information under this Article 10 must be disclosed in writing or in another tangible medium and must be clearly marked “CONFIDENTIAL” or the like. Property disclosed orally or visually that the Disclosing Party desires to keep confidential must be summarized and reduced to writing and communicated to the Receiving Party within thirty (30) days of such disclosure.

10.03 Exceptions of Confidential Disclosures . Notwithstanding the foregoing of this Article 10, the Parties may use and disclose any confidential information related to the Patent Rights to BAT Affiliates (if BAT) or 22nd Century Affiliates (if 22nd Century) and their potential sublicensees, prospective investors, employees, consultants and agents with a need to know, collaborators, prospective collaborators and other third parties in the chain of growing, manufacturing and distributing Licensed Products, but if and only if the applicable party obtains from each such recipient a written confidentiality agreement, the provisions of which are at least as protective of 22nd Century’s confidential information as those provided in this Article 10.

10.04 Confidentiality Related to Patent Rights . Notwithstanding anything to the contrary in this Agreement, all information relating to filing, prosecution, maintenance, defense, infringement, and the like regarding the Patent Rights (no matter how disclosed) is the confidential information of 22nd Century and subject to the provisions of this Article 10.

ARTICLE 11 – GOVERNING LAW AND ARBITRATION

11.01 Governing Law . As the Parties will be doing business in different locations, and seek certainty in their dealings with each other and with third parties, the Parties to this Agreement expressly acknowledge and agree that this Agreement, and the performance or breach thereof, shall be entered into, interpreted, governed, construed, and enforced in accordance with the substantive and procedural laws of the State of New York , United States of America, without regard to any choice of law principles. The Parties hereby irrevocably submit to the exclusive personal jurisdiction of the state and federal courts located in or serving the State of New York, United States of America, for the purposes of any claim, action or proceeding brought pursuant to or arising from this Agreement.

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11.02 Arbitration . Any and all disputes arising out of or in connection with this Agreement, and/or any breach of this Agreement by BAT, any BAT Affiliates, 22nd Century, any 22nd Century Affiliates, any licensees and/or any sublicensees of the foregoing under this Agreement will be referred to and finally resolved by arbitration administered by the International Centre for Dispute Resolution in accordance with the International Arbitration Rules. Each Party shall be entitled to seek interim, interlocutory or permanent injunctive relief from any state or federal court located in the State of New York, United States of America, and the parties hereby agree to submit to the exclusive personal jurisdiction of the state and federal courts located in or serving the State of New York, United States of America, for the purposes of any claim, action or proceeding brought pursuant to or arising from this Agreement. The Parties agree that the arbitration proceedings will be conducted in New York City, State of New York, United States of America. The language of the proceedings and all results thereof shall be in English. All arbitration proceedings will be conducted before a single arbitrator selected by the relevant arbitration commission, provided that such arbitrator shall have experience in conducting business arbitration with respect to intellectual property licensing. The decision resulting from the arbitrator shall be final, not appealable except with respect to any point of law, and binding on the Parties and any judgment on the award rendered by the arbitrator may be entered in any court having jurisdiction.

11.03 Injunctive Relief . Each Party agrees that the other Party’s remedies at law for any breach of its obligations of this Agreement (other than pure payment obligations) will or may be inadequate alone, and that such other Party shall be entitled to equitable relief, including, without limitation, injunctive relief and specific performance, in addition to any other available remedies it may have in law and in equity, and such Party hereby waives any requirement for security or posting of any bond in connection with any such remedy.

ARTICLE 12 – NOTICES

12.01 Notices .

(a) All Notices (as defined in Section 12.02) by a Party to the other Party shall be sent to such other Party to at least the following address and attention of such other Party (or such other address and/or attention as such other Party has notified by written Notice to the Party sending the Notice at least thirty (30) days prior to such Notice):

If to BAT:	If to 22nd Century:

British American Tobacco (Investments) Limited	22nd Century Limited, LLC
Attention: Head of Marketing Legal	Attention: Joseph Pandolfino
Globe House	9530 Main Street
4 Temple Place	Clarence, New York 14031
London WC2R 2PG	United States of America
United Kingdom
	If to 22nd Century Group:

	22nd Century Group, Inc.
	Attention: Joseph Pandolfino
	9530 Main Street
	Clarence, New York 14031
	United States of America

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(b) A copy of any Notice sent to a Party under Section 12.01(a) shall be sent simultaneously to such Party to the following (whereby such copy shall not be deemed to be notice):

If such notice, demand, or written communication is to BAT, to each of the following:	If such notice, demand, or written communication is to 22nd Century or 22nd Century Group, to
	each of the following:
(1) British American Tobacco (Investments) Limited
Attention: Head of Patents and Innovations	(1) 22nd Century Limited, LLC
Globe House	Attention: Michael R. Moynihan, PhD
4 Temple Place	9530 Main Street
London WC2R 2PG	Clarence, New York 14031
United Kingdom	United States of America

(2) By e-mail to:	(2) By email to:
(3) By e-mail to:	(3) By email to:

A copy of any Notice by 22nd Century to BAT under Section 1.12(iv) shall also be sent by 22nd Century simultaneously to:

by mail to:	British American Tobacco (Investments) Limited
	Attention: Head of Group Research & Development [Cambridge]
	210 Cambridge Science Park
	Milton Road
	Cambridge CB4 0WA
	United Kingdom

and by e-mail to:

12.02 Delivery . The Parties agree that any notice or demand sent by a Party to the other Party (including, without limitation, exercising the Option, notice of termination, notice of breach, notice of infringement, demand, notice under Section 1.14(iv), or any other notice resulting in a deadline or having legal consequences under this Agreement) (“Notice”) must be sent to such Party at the address and to the attention as stated for such Party in Section 12.01(a) by a reputable internationally recognized carrier with a delivery confirmation or tracking number (charges prepaid). The date on which any such Notice to a Party is deemed given to such Party shall be the date of the delivery by such internationally recognized carrier to such Party at the address and to the attention as set forth in Section 12.01(a) for such Party.

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ARTICLE 13 – SUCCESSORS, ASSIGNMENT AND CHANGE OF CONTROL

13.01 Successors . This Agreement is binding upon and inures to the benefit of the respective successors and assigns of the Parties hereto.

13.02 No Assignments . This Agreement may not be transferred or assigned by either Party except: (i) that BAT may transfer or extend this Agreement to any BAT Affiliate (subject to a reasonable guaranty by BAT of such BAT Affiliate’s performance after such transfer), or (ii) that either Party may transfer this Agreement in connection with the sale or other transfer of such Party’s entire business, as the case may be, except in the event of a sale or other transfer by 22nd Century to a Competitor Party, in which case the provisions in Section 13.03 shall apply to the same extent as in the event of a change of control set forth therein. Any other assignment of this Agreement without the prior written consent of the other Party shall be null and void.

13.03 Change of Control . In the event a Competitor Party takes control of 22nd Century by obtaining more than fifty percent (50%) of the common stock of 22nd Century Group, Inc., BAT’s rights under this Agreement will be unaffected, but BAT’s obligations under this Agreement shall be amended automatically (without need for any notice or other action) and effective immediately upon such change of control as follows:

(a) BAT’s obligations in Sections 4.03, 4.04, and 4.05 shall terminate; and

(b) BAT obligation to pay any further Milestone Fees pursuant to Section 5.02 shall terminate.

All other provisions of this Agreement will remain unchanged.

ARTICLE 14 – INDEMNITY, REPRESENTATIONS AND DISCLaimer

14.01 Indemnity . 22nd Century and 22nd Century Group shall indemnify, defend and hold harmless BAT, all BAT Affiliates, and each of its officers, directors, employees, agents, and licensors, and their respective successors and assigns (collectively, “BAT Indemnitee(s)”), by counsel selected by 22nd Century, from and against any claim, liability, cost, expense, demand, action, suit, proceeding, damages, judgment, penalty, deficiency, loss or obligation, of any kind or nature (including, without limitation, reasonable attorneys’ fees and other costs and expenses of defense) (collectively, “Claims”) based upon, arising out of, or otherwise relating, directly or indirectly, to any breach, or allegation giving rise to any breach, of any warranty or representation of 22nd Century under Section 14.02. A BAT Indemnitee shall provide 22nd Century with reasonably prompt written notice of such a Claim. 22nd Century shall have the right to compromise or settle such Claim; provided, however, that (i) no compromise or settlement of any such Claim may be effected by 22nd Century without the consent of BAT unless (i) there is no finding or admission of any violation of law or the rights of any person by a BAT Indemnitee, (ii) no such compromise or settlement has an adverse effect on any other claims that may be made by a BAT Indemnitee against 22nd Century, (iii) the sole remedy provided thereunder is monetary damages which will be paid in full by 22nd Century in accordance with such compromise or settlement and 22nd Century reasonably demonstrates its financial capacity to do so, and (iv) no such compromise or settlement has an adverse effect on any consideration to be received by BAT under this Agreement.

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14.02 Warranties and Representations of 22nd Century . 22nd Century warrants and represents that (a) as of the Effective Date it either owns or is the exclusive worldwide licensee of the Patent Rights in the Field of Use, (b) it has the sole and unrestricted right to grant the Research License and Option for the Commercial License provided in this Agreement, subject to the limitations set forth in Sections 2.05 and 2.06 , (c) performance of its obligations under this Agreement does not and will not violate any existing agreement to which it is subject or a party, (d) the execution of this Agreement has been duly authorized and 22nd Century’s performance hereunder is within its corporate power, and (e) to 22nd Century’s knowledge, as of the date of signing this Agreement, the Patent Rights will not infringe any third party’s rights. 22nd Century warrants and represents that the wire transfer instructions supplied under Section 5.01 are and will remain correct, complete, and sufficient for BAT to make any payments under this Agreement to 22nd Century unless and until 22nd Century provides BAT written notice of different wire transfer instructions, in which case 22nd Century warrants and represents that such different wire transfer instructions are and will remain correct, complete, and sufficient for BAT to make any payments under this Agreement to 22nd Century.

14.03 Indemnity . BAT shall indemnify, defend and hold harmless 22nd Century, all 22nd Century Affiliates, and each of its officers, directors, employees, agents, and licensors, and their respective successors and assigns (collectively, “22nd Century Indemnitee(s)”), by counsel selected by BAT, from and against any claim, liability, cost, expense, demand, action, suit, proceeding, damages, judgment, penalty, deficiency, loss or obligation, of any kind or nature (including, without limitation, reasonable attorneys’ fees and other costs and expenses of defense) (collectively, “Claims”) of any third party (other than any BAT Affiliate or 22nd Century Affiliate) asserting any product liability claim against a 22nd Century Indemnitee arising from any tobacco developed by BAT funded activities under this Agreement grown, made, imported, exported, sold, offered for sale or used by or behalf of BAT or any BAT Affiliate and/or any Licensed Product grown, made, imported, exported, sold, offered for sale or used by or behalf of BAT or any BAT Affiliate. A 22nd Century Indemnitee shall provide BAT with reasonably prompt written notice of such a Claim. BAT shall have the right to compromise or settle such Claim; provided, however, that (i) no compromise or settlement of any such Claim may be effected by BAT without the consent of 22nd Century unless (i) there is no finding or admission of any violation of law or the rights of any person by a 22nd Century Indemnitee, (ii) no such compromise or settlement has an adverse effect on any other claims that may be made by a 22nd Century Indemnitee against BAT, (iii) the sole remedy provided thereunder is monetary damages which will be paid in full by BAT in accordance with such compromise or settlement and BAT reasonably demonstrates its financial capacity to do so, and (iv) no such compromise or settlement has an adverse effect on any consideration to be received by 22nd Century under this Agreement.

14.04 Warranties and Representations of BAT . BAT warrants and represents that (a) performance of its obligations under this Agreement does not and will not violate any existing agreement to which it is subject or a party, and (b) the execution of this Agreement has been duly authorized and its performance hereunder is within its corporate power.

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14.05 Disclaimer . OTHER THAN AS PROVIDED IN SECTION 14.02 (FOR 22ND CENTURY) OR 14.03 (FOR BAT), NEITHER PARTY NOR ANY OF SUCH PARTY’S AFFILIATES MAKES ANY, AND ALL OF THEM DISCLAIM ALL, WARRANTIES, REPRESENTATIONS, AND CONDITIONS OF ANY KIND, EXPRESS OR IMPLIED OR LEGAL, INCLUDING, WITHOUT LIMITATION, ANY WARRANTIES, REPRESENTATIONS, OR CONDITIONS OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR WORKMANSHIP OR TITLE OR NON-INFRINGEMENT, NOR IS THERE A WARRANTY, REPRESENTATION, OR CONDITION THAT THE USE OF THE PATENT RIGHTS OR ANY RESEARCH RESULT, PROPERTY, OR ACTIVITY OF THIS AGREEMENT WILL NOT INFRINGE ANY PATENT, COPYRIGHT, TRADEMARK OR OTHER RIGHTS. IN ADDITION, NOTHING IN THIS AGREEMENT MAY BE DEEMED TO BE A REPRESENTATION OR WARRANTY BY 22ND CENTURY OF THE VALIDITY OF ANY OF THE PATENTS OR THE ACCURACY, SAFETY, EFFICACY, OR USEFULNESS, FOR ANY PURPOSE, OF THE PATENT RIGHTS, OR ANY REPRESENTATION, WARRANTY, OR CONDITION BY BAT OR ANY BAT AFFILIATE OF THE VALIDITY, ACCURACY, SAFETY, EFFICACY, OR USEFULNESS, FOR ANY PURPOSE, OF ANY RESEARCH RESULT. 22ND CENTURY HAS NO OBLIGATION, EXPRESS OR IMPLIED, TO SUPERVISE, MONITOR, REVIEW OR OTHERWISE ASSUME RESPONSIBILITY FOR THE PRODUCTION, MANUFACTURE, TESTING, MARKETING OR SALE OF ANY LICENSED PRODUCT BY BAT OR ITS AFFILIATES. 22ND CENTURY HAS NO LIABILITY WHATSOEVER TO BAT OR ANY THIRD PARTIES FOR OR ON ACCOUNT OF ANY INJURY, LOSS, OR DAMAGE, OF ANY KIND OR NATURE, SUSTAINED BY, OR ANY DAMAGE ASSESSED OR ASSERTED AGAINST, OR ANY OTHER LIABILITY INCURRED BY OR IMPOSED UPON BAT OR ANY OTHER PERSON OR ENTITY, ARISING OUT OF OR IN CONNECTION WITH OR RESULTING FROM THE USE OF THE PATENT RIGHTS BY BAT. IN NO EVENT SHALL EITHER PARTY BE LIABLE, REGARDLESS OF THE BASIS OR GROUND OF LIABILITY, FOR ANY INDIRECT, INCIDENTAL, CONSEQUENTIAL, EXEMPLARY, LIQUIDATED, SPECIAL, OR PUNITIVE DAMAGES OR LOSSES, INCLUDING, WITHOUT LIMITATION, LOST PROFITS AND LOST BUSINESS, WHETHER FORESEEABLE OR NOT, EVEN IF IT HAS BEEN ADVISED OF THE POSSIBILITY THEREOF, UNDER THIS AGREEMENT.

ARTICLE 15 – BANKRUPTCY

15.01 Bankruptcy etc. of 22nd Century . To the greatest extent permissible under applicable law, none of the licenses and rights granted to BAT under this Agreement shall terminate, expire, be limited or restricted, or adversely modified or affected in the event that 22nd Century or any 22nd Century Affiliate, or any licensor thereof, ceases or fails to conduct business operations, takes steps to dissolve or cease to exist, files or is or becomes subject to a petition in bankruptcy (or similar reorganization proceeding), admits its inability to pay its debts as they become due, makes a general assignment for the benefit of its creditors, or becomes subject to the appointment of a receiver. This Agreement and the rights and licenses to BAT are subject to 11 U.S.C. § 365(n) and the right of BAT to elect retention of this Agreement and the licenses and rights to BAT hereunder if BAT so decides in its sole discretion. In the event of any bankruptcy or other such event as described above in this Section 15.01, to the greatest extent permissible under applicable law, 22nd Century will assert the continuation of any licenses granted to 22nd Century or any 22nd Affiliate and sublicensed to BAT under this Agreement. 22nd Century will further promptly engage in such acts as reasonably requested by BAT to 22nd Century to ensure BAT’s continued rights under the licenses granted by 22nd Century under this Agreement and/or BAT’s continued rights arising or flowing from any licenses granted to 22nd Century or 22nd Century and sublicensed to BAT under this Agreement under substantially the same terms as those in effect immediately prior to the bankruptcy or other such event as described above in this Section 15.01.

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15.02 Cooperation . If any of the events identified in Section 15.01 occurs or is likely to occur, 22nd Century shall promptly notify BAT thereof in writing and provide BAT with all information requested by BAT related thereto. In such case, if and to the extent legally permissible under applicable law, the Parties will cooperate with external legal and other advisers (each Party bearing its own cost related thereto) to identify the best option or options to protect BAT and BAT Affiliates’ access to the Licensed Intellectual Property Rights in or despite such event. 22nd Century agrees that, in any such event, it will undertake all as legally permissible under applicable law to ensure that none of BAT’s rights and licenses under this Agreement are terminated, limited, restricted, or adversely modified or affected.

ARTICLE 16 – USE OF A PARTY'S NAME

16.01 Unless required by operation of law, rule or regulation, including without limitation any securities law, rule or regulation, or any binding judgment or court order or any requirement of a competent authority, neither 22nd Century nor any 22nd Century Affiliate may publish or disclose this Agreement, the existence of this Agreement, or any of the provisions of this Agreement (except: (i) if and to the extent expressly permitted by BAT in an advance written notice to 22nd Century, which shall be in BAT’s discretion, or (ii) to each other, or (iii) to any legal or financial consultant subject to an obligation of confidentiality regarding such disclosure or as necessary for, and in the course of, enforcing any of their rights under this Agreement), and none of the Parties may, without the prior written consent of the other applicable Party:

(a) use in any publication, advertising, publicity, press release, or promotional activity or otherwise, any trade-name, personal name, trademark, trade device, service mark, symbol, image, icon, or any abbreviation, contraction or simulation thereof owned by the other Party; or

(b) use the name or image of any employee or agent of the other Party in any publication, publicity, advertising, press release, promotional activity or otherwise.

None of the Parties may, without the prior written consent of the other applicable Party, represent, either directly or indirectly, that any product or service of the other Party is a product or service of the representing Party or that it is made in accordance with or utilizes the information or documents of the other Parties.

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ARTICLE 17 – GUARANTY

17.01 22nd Century Group hereby guarantees to BAT the performance of any and all obligations, and any and all liability, of 22nd Century under this Agreement, including, without limitation, all payments owed and due by 22nd Century to BAT, to the same extent as if such obligations and liability were direct obligations and liabilities of 22nd Century Group to BAT. The guaranty in this Article 17 is an absolute, unconditional, and irrevocable continuing guaranty, which shall be effective as long as this Agreement is in effect, and thereafter with regard to any obligation or liability of 22nd Century that accrued before, or that survives, the termination, expiration, or cancellation of this Agreement until all such obligations and liabilities have been satisfied in full. 22nd Century Group hereby waives, relinquishes, and abandons any right to request, demand, or require BAT first to claim or pursue any right or remedy of any kind against 22nd Century for all or any part of any obligations or liability guaranteed by 22nd Century Group under this Article 17. 22nd Group hereby confirms and agrees that its obligations and liability under the guaranty in this Article 17 shall be in effect, enforceable, and not be waived, relinquished, or abandoned in the event of, any amendment or change of this Agreement. 22nd Century Group hereby waives notice of any amendment or change of this Agreement. Nothing in this Article 17 waives any right of any Party to assert, to bring any action for, or to enforce any right or remedy by such Party against the other or any direct obligation or liability of 22nd Century Group under Section 14.01.

17.02 In the event 22nd Century Group no longer has any ownership interest in 22nd Century after the Effective Date, then 22nd Century Group may from and after that time request BAT to consent to the release of 22nd Century Group from the guaranty in this Article 17 and any obligation or liability of 22nd Century Group under Section 14.01, which consent BAT shall not unreasonably withhold, condition or delay as long as (i) the entity which then owns 22nd Century (“New Owner”) agrees in a written agreement with BAT to be bound by the guaranty in this Article 17 and any obligation or liability of 22nd Century Group under Section 14.01 to the full extent as set forth therein for 22nd Century Group, (ii) New Owner is also of equal or greater financial strength as compared to 22nd Century Group at the time of such request, (iii) 22nd Century and 22nd Century Group provides to BAT all information reasonably necessary to assess the financial strength of New Owner (which provision of the last such information, 22nd Century and 22nd Century Group shall be deemed to warrant and represent that neither of them nor any 22nd Century Affiliate has any further such information), and (iv) 22nd Century shall pay, and 22 Century Group hereby guarantees under the same terms as set forth in Section 17.01, full payment of BAT’s reasonable legal expenses arising from the release of 22nd Century Group from the guaranty in this Article 17 and/or New Owner’s agreements under Section 17.02(i). BAT enters into this Agreement in reliance upon 22nd Century Group’s guaranty and the provisions in this Article 17.

ARTICLE 18 – SEVERANCE AND WAIVER

18.01 Severance . Each clause of this Agreement is a distinct and severable clause and if any clause is deemed illegal, void or unenforceable, the validity, legality or enforceability of any other clause or portion of this Agreement will not be affected.

18.02 Waiver . The failure of a Party in any instance to insist upon the strict performance of the terms of this Agreement is not a waiver or relinquishment of any of the terms of this Agreement, either at the time of the Party’s failure to insist upon strict performance or at any time in the future, and such terms will continue in full force and effect.

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ARTICLE 19 – TITLES AND DRAFTING

19.01 Titles . All titles, section headings and article headings contained in this Agreement are inserted only as a matter of convenience and reference. They do not define, limit, extend or describe the scope of this Agreement or the intent of any of its provisions.

19.02 Drafting . For purposes of construing this Agreement, each of the Parties shall be deemed the drafter of this Agreement.

ARTICLE 20 – SURVIVAL OF TERMS

20.01 The provisions of Articles 1 (with regard to any definition used in any of the following surviving terms), 10, 11, 12, 14 (with regard to any Claim thereunder arising prior to the expiration or termination of this Agreement), 16, 17, 18, 19, and 21, this Article 20, and Sections 2.07, 4.05, and 6.02 (if and to the extent that any payment under such Section 6.02 is due and unpaid) shall survive the expiration or termination of this Agreement.

ARTICLE 21 – ENTIRE UNDERSTANDING

21.01 This Agreement represents the entire understanding among the Parties, and supersedes all other agreements, express or implied, among the Parties concerning the subject matter hereof, and is not subject to any change or modification except by the execution of a written instrument subscribed to by authorized representatives of the Parties.

ARTICLE 22 – ELECTRONIC COPY; COUNTERPARTS

22.01 The Parties to this document agree that a copy of the original signature (including an electronic copy) may be used for any and all purposes for which the original signature may have been used. The Parties further waive any right to challenge the admissibility or authenticity of this document in a court of law based solely on the absence of an original signature.

22.02 This Agreement may be executed in several counterparts, each of which will be deemed an original, but all of which together will constitute one and the same instrument.

[Signature page follows.]

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IN WITNESS WHEREOF , the Parties have executed this Agreement as of the Effective Date.

BAT:		22ND CENTURY:

British American Tobacco (Investments) Limited		22nd Century Limited, LLC

By:	/s/ Gary Nicholson	By:	/s/ Joseph Pandolfino
Name:	Gary Nicholson (Authorised Signatory)	Name:	Joseph Pandolfino
Title:	Head of Global Leaf Research	Title:	Chief Executive Officer

By:	/s/ Steve Burton
Name:	Steve Burton (Authorised Signatory)
Title:	Head of CORA and GR&D Finance

For the limited purpose of indemnity provided in Section 14.01 and Article 17:

22nd Century Group, Inc.

By:	/s/ Joseph Pandolfino
Name:	Joseph Pandolfino
Title:	Chief Executive Officer

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APPENDIX A

BAT AFFILIATES

( without limitation )

No.		Centre Corporate Companies
1		B.A.T (U.K. and Export) Ltd
2		B.A.T Capital Corporation (incorp. in the U.S.)
3		B.A.T. International Finance p.l.c.
4		BATMark Ltd.
5		British-American Tobacco (Holdings) Ltd.
6		British American Tobacco Holdings (The Netherlands) B.V.
7		British American Tobacco International Ltd. (incorp. in Switz.)
8		British American Tobacco (Brands) Inc. (incorp. in the U.S.)
9		British American Tobacco (Brands) Ltd.
10		British American Tobacco (GLP) Ltd.
11		British American Tobacco (Investments) Ltd.
		Asia-Pacific
12		British American Tobacco Australia Ltd.
13		British American Tobacco Bangladesh Company Ltd.
14		PT Bentoel Internasional Investama Tbk (Indonesia)
15		British American Tobacco Japan, Ltd.
16		British American Tobacco (Malaysia) Berhad
17		British American Tobacco (New Zealand) Ltd.
18		Pakistan Tobacco Co. Ltd.
19		British American Tobacco Korea Ltd.
20		British American Tobacco Korea Manufacturing Ltd.
21		B.A.T Services Ltd. (Taiwan, incorporated in the UK)
22		British-American Tobacco Marketing (Singapore)
		Americas
23		za-Piccardo S.A.I.C.y F. (Argentina)
24		Souza Cruz, S.A. (Brazil)
25		Imperial Tobacco Canada Ltd.
26		British American Tobacco Chile Operaciones, S.A.
27		British American Tobacco Colombia S.A.S.
28		British American Tobacco Mexico, S.A. de C.V.
29		C.A. Cigarrera Bigott Sucs. (Venezuela)
30		British American Tobacco Belgium S.A.
		Western Europe
31		British American Tobacco (Czech Republic), s.r.o.
32		British American Tobacco Denmark A/S
33		British American Tobacco France SAS
34		British-American Tobacco (Germany) GmbH
35		British American Tobacco (Industrie) GmbH
36		BAT Pecsi Dohnygyr Kft. (Hungary)
37		British American Tobacco Italia S.p.A.
38		British American Tobacco Nederland B.V.
39		British American Tobacco Western Europe Region B.V.
40		British-American Tobacco Polska S.A.
41		British American Tobacco Polska Trading sp. zo.o.
42		British-American Tobacco (Romania) Trading SRL
43		British American Tobacco España, S.A.
44		British American Tobacco Sweden AB
45		Fiedler & Lundgren AB
46		British American Tobacco Switzerland S.A.
47		British American Tobacco UK Ltd.
		Eastern Europe, Middle East and Africa
48		British American Tobacco (Algérie) S.P.A.
49		British American Tobacco Egypt LLC
50		B.A.T. Pars Company (Private Joint Stock) (Iran)
51		British American Tobacco Kazakhstan Trading LLP
52		British American Tobacco Exports B.V. (Morocco)
53		British American Tobacco (Nigeria) Ltd.
54		OJSC British American Tobacco – STF (Russia)
55		OJSC British American Tobacco – Yava (Russia)
56		CJSC British American Tobacco – SPb (Russia)
57		CJSC International Tobacco Marketing Services
58		B.A.T. Tobacco Holdings South Africa (Pty) Ltd
59		B.A.T. Tütün Mamulleri Sanayi ve Ticaret A.S. (Turkey)
60		A/T B.A.T. – Prilucky Tobacco Co. (Ukraine)

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Appendix B

PATENT RIGHTS

Patent Family

Country/
Region

No.

Application No.

Filing
Date

Patent No.

Date
Issued

Assignee

ARIPO

AP/P/2007/004181

2/28/06

22nd Century

Australia

2006233359

2/28/06

2006233359

7/19/12

22nd Century

2012203977

7/5/12

22nd Century

Canada

2599302

2/28/06

22nd Century

Reducing Levels of Nicotinic

China

200680010544.X

2/28/06

200680010544.X

9/5/12

22nd Century

Alkaloids in Plants

2012102520317

7/19/12

22nd Century

PCT/IB2006/001741

Hong Kong

13109543.8

8/15/13

22nd Century

(WO2006109197)

Japan

P2007-557629

2/28/06

4892744

1/6/12

NAIST*

Korea

2007-7022315

2/28/06

22nd Century

Filed on 02-28-2006

2013-7006598

3/14/13

22nd Century

Mexico

2007/010520

2/28/06

301367

7/16/12

22nd Century

2012/008279

7/16/12

305368

11/16/12

22nd Century

2012/013312

11/15/12

22nd Century

Philippines

1-2007-501841

2/28/06

22nd Century

South Africa

2007/08331

2/28/06

2007/08331

9/30/09

22nd Century

United States

11/579661

2/28/06

22nd Century

13/082953

4/8/11

22nd Century

Increasing Levels of

Europe

06848676.0

9/13/06

22nd Century

Nicotinic Alkaloids

11187201.6

10/28/11

22nd Century

Hong Kong

12110455.3

10/19/12

22nd Century

PCT/IB2006/004043

Japan

2009-537707

9/13/06

5087777

9/21/12

NAIST*

(WO2007072224)

Taiwan

096116136

5/7/07

Notice of Allowance

22nd Century

Filed 9/13/06

United States

11/520036

9/13/06

22nd Century

Nucleic Acid Sequences

Canada

2688306

5/23/08

NRC**

Encoding Transcription

China

200880100279.3

5/23/08

NRC**

Factors Regulating Alkaloid

Hong Kong

11113618.2

5/23/08

NRC**

Biosynthesis and Their Use

12/601752

5/23/08

NRC**

in Modifying Plant

United States

13/464,212

5/4/12

NRC**

Metabolism

PCT/IB2008/003131 (WO/2009/063312)

Filed on 5-23-2008

*22nd Century holds a non-exclusive license from the Nara Institute of Science and Technology (NAIST) with the right to sublicense.

**22nd Century holds an exclusive worldwide license from the National Research Council of Canada (NRC) with the exclusive right to sublicense.

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Schedule 1

COMMERCIAL LICENSE AGREEMENT

This Commercial License Agreement (this “Agreement”) is entered into as of the Option Effective Date (as defined below) by and among 22nd Century Limited, LLC (“22nd Century”) and 22nd Century Group, Inc. (“22nd Century Group”), each with its corporate headquarters at 9530 Main Street, Clarence, New York 14031, United States of America, and British American Tobacco (Investments) Limited (“BAT”), Reg. No. 00074974, with its registered office at Globe House, 1 Water Street, London WC2R 3LA, United Kingdom.

WHEREAS :

BAT and 22nd Century entered into that certain Research License and Commercial Option Agreement dated as of September 30, 2013 (the “Research License Agreement”), in which 22nd Century granted BAT an exclusive option to enter into this Agreement.

BAT exercised such option causing this Agreement to be effective as of the date of the Commercial License Commencement (as defined in the Research License Agreement) (the “Option Effective Date”).

BAT and 22nd Century wish to enter into this Agreement for 22nd Century to grant to BAT, and for BAT to receive, the licenses and rights set forth in this Agreement under the terms and conditions set forth in this Agreement.

NOW THEREFORE , the Parties agree as follows:

ARTICLE 1 – DEFINITIONS

For the purposes of this Agreement, the terms and phrases below have the following definitions:

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[*] = CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

1.04 “Article” means any of the numbered Articles of this Agreement.

1.05 “Available for Shipment” means Commercial Licensed Products which have been (i) harvested, (ii) processed in a leaf processing facility of BAT or a BAT Affiliate or a third party with whom BAT or a BAT Affiliate has contracted, and (iii) inspected and cleared for shipment.

1.07 “BAT Excluded Businesses” means any of the following companies if and after such company becomes part of BAT or a BAT Affiliate after the Option Effective Date of the Research License by merger, acquisition or business combination, but only while it is part of BAT or a BAT Affiliate: [*], and any of the foregoing companies’ respective Affiliates.

1.08 “BAT Excluded Products” means solely any Commercial Licensed Product that is (i) Available for Shipment to any third party that is not a BAT Affiliate or Reynolds, (ii) the amount of Commercial Licensed Products actually shipped to any third party that is not a BAT Affiliate or to Reynolds in an amount which is greater than the amount under the immediately preceding clause (i), and/or (iii) is processed in a leaf processing facility of Reynolds or a third party with whom Reynolds has contracted.

1.09 “Affiliate” or “Affiliates” means, with respect to any entity other than a 22nd Century Affiliate, BAT Affiliate, or Reynolds Affiliate, any corporation, company or other entity which directly or indirectly controls, is controlled by, or is under common control with such entity. “Control” of an entity shall mean possession, directly or indirectly, of power to direct or cause the direction of management or policies of such entity, whether through ownership of voting securities, by contract, or otherwise.

1.10 “BAT Supplier” means any party which supplies BAT or any BAT Affiliates with Licensed Product which is grown from seeds provided to such party by BAT or a BAT Affiliate and with respect to which BAT or a BAT Affiliate purchases for itself all of the Licensed Product grown by such BAT Supplier. For the avoidance of doubt, any Licensed Product grown by a BAT Supplier which is not destroyed shall only be used by BAT or a BAT Affiliate for processing in a BAT leaf processing facility for conversion of such tobacco leaf into a tobacco leaf packaged product which, at any time during the Commercial Term, will, or is intended to, ultimately become a Commercial Licensed Product (as defined in Section 1.12 below) Available for Shipment (as defined in Section 1.05 above).

1.11 “Co-exclusive Term” means the initial three (3) Years of the Commercial Term.

1.12 “Commercial Licensed Product” means a Licensed Product which is harvested tobacco leaf processed in a leaf processing facility and any commercial product containing such harvested tobacco leaf or parts or extracts thereof. For the avoidance of doubt, Commercial Licensed Products do not include, without limitation, Licensed Products which are seeds.

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[*] = CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

1.13 “Competitor Party” means the following [*].

1.14 “Commercial Term” means the period of time commencing on the Option Effective Date and continuing uninterrupted until the later of (i) the expiration, invalidation of all claims of, or cancellation of the last to expire of the Patent Rights, or (ii) in the event Plant Variety Rights are granted for any plant variety that is a Licensed Product, the expiration, invalidation of all claims of, or cancellation of such Plant Variety Rights .

1.15 “Field of Use” means any and all use of Nicotiana plants or parts thereof and tobacco and products produced therefrom, including, without limitation, cigarettes, heat-not-burn cigarettes, electronic cigarettes, cigars, tobacco for smoking in pipes or by other means, all forms of smokeless tobacco (such as snus, chewing tobacco, snuff and tobacco dissolvables), and nicotine products. Field of Use shall, however, exclude solely: (i) products (other than combustible cigarettes and cigars, electronic cigarettes and heat-not-burn products) produced from tobacco biomass, including, without limitation, plant proteins, pharmaceutical products other than nicotine products, nutritional products, food and feed ingredients, and biofuels; and (ii) solely in the United States of America, a combustible cigarette product that has been approved for smoking cessation by the Center for Drug Evaluation and Research (CDER) of the U.S. Food and Drug Administration and is intended and offered for smoking cessation. For the avoidance of doubt, the carve out in (ii) above shall not encompass products which may have been approved as a reduced risk product by the U.S. Food and Drug Administration or any other U.S. regulatory body.

1.16 “First Commercial Term” means the initial three (3) Years of the Full Term.

1.17 “First Day” means: (i) the Option Effective Date if the Option Effective Date is the first day of a calendar month or (ii) the first day of the calendar month next following the Option Effective Date if the Option Effective Date is not the first day of a calendar month.

1.18 “Full Term” means the period of time from expiration of the Pilot Term and extending for the remainder of the Commercial Term.

1.19 “Licensed Intellectual Property Rights” means individually any, and collectively all, of the following:

(i)

all of the Patent Rights;

(ii)

all of the Plant Variety Rights;

(iv) all know-how, copyrights, and/or trade secrets related to the Patent Rights that are:

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(aa)

acquired by ownership or co-ownership or licensed (with the right to sublicense) at any time after the Commencement Date by 22nd Century or a 22nd Century Affiliate, and

(bb)

disclosed to BAT pursuant to this Agreement by or on behalf of 22nd Century or any 22nd Century Affiliate,

1.20 “Licensed Product(s)” means any materials, products or parts thereof, including without limitation any plants, harvested plant parts, seeds, cell lines, strains, genes, DNA, nucleic acid sequences and/or other tangible biological materials, which:

(a) are covered, in whole or in part, by an issued, unexpired claim or pending claim contained in the Patent Rights in any country;

(d) are covered, in whole or in part, by any Plant Variety Rights in any country in which any such material, product or part thereof is grown, made, used, sold, imported, exported or transferred.

1.21 “Non-exclusive Term” means the period of time from expiration of the Co-exclusive Term and extending through the remainder of the Term.

1.22 “Non-Patent Rights” means, collectively, any and all copyrights, mask work rights, and similar rights, and registrations, and applications for registration, thereof, and any and all rights of or protecting trade secrets, know-how, computer programs, algorithms, databases, and data, and any and all other intellectual, industrial, or proprietary rights, known or recognized now or in the future.

1.23 “Party” means, individually, 22nd Century or BAT, as the case may be, and also 22nd Century Group with regard to Section 13.01(a) and Article 16.

1.24 “Parties” means, collectively, 22nd Century and BAT, and also 22nd Century Group with regard to Section 13.01(a) and Article 16.

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[*] = CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

1.25 “Patent Rights” means, collectively, all of the following (a) each of the patents and patent applications listed in Appendix B ; (b) any and all applications claiming the benefit of the filing date or claiming priority for any of the foregoing patent applications, including without limitation any divisional applications, continuation applications, continuation-in-part applications, reissue applications, reexaminations and extensions, and any foreign corresponding or counterpart international, regional and national applications; and (c) any and all patents issuing or reissuing from any of the foregoing patent applications.

1.26 “Permitted Researcher” means any of the following entities, but only if and after such entity has entered into a Permitted Researcher Agreement with 22nd Century or a 22nd Century Affiliate and only while such Permitted Researcher Agreement is in effect: (i) an academic institution, or (ii) an entity that does not, and none of whose Affiliates, in any way, directly or indirectly, manufacture, offer for sale, distribute, and/or sell tobacco or tobacco products and the research conducted by such entity is under the direction, funding or control of 22nd Century or a 22nd Century Affiliate. The term “Permitted Researcher” shall include, without limitation, [*].

1.27 “Permitted Researcher Agreement” means a legally binding written agreement entered into and signed by 22nd Century or a 22nd Century Affiliate with an entity that (other than the execution of a Permitted Researcher Agreement) qualifies as a Permitted Researcher and includes:

(i)

confidentiality obligations which are either:

(aa)

no less rigorous than the confidentiality obligations of the Parties under this Agreement, or,

(bb)

(A)

(B)

any Property related to the Patent Rights delivered, provided, or made available to such Permitted Researcher by 22nd Century or a 22nd Century Affiliate; and

(ii)

an obligation to assign, transfer, convey or license to 22nd Century all rights, title and interest in any Property resulting from the research conducted by such entity.

1.28 “Pilot Term” means the initial two (2) Years of the Commercial Term.

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1.29 “Plant Variety Rights” or “PVR” means intellectual property in the form of rights granted by applicable law to the breeder of a new variety of plant that give the breeder control over the propagating material or harvested material of a plant variety or the use thereof (such as for example, “Plant Variety Protection,” “PVP Certificates,” “Plant Variety Right Certificates,” and “Plant Breeders’ Rights Certificates,” and any other rights granted by a member state of the International Union for the Protection of New Varieties of Plants (UPOV) to comply with the International Convention for the Protection of New Varieties of Plants (UPOV Convention)), which variety: (i) is a result of the research and development funded by BAT or any BAT Affiliate (no matter who is the plant breeder) and (ii) is covered by the Patent Rights at the time of filing an application for PVR.

1.30 “Property” means, individually and collectively, any invention, development, discovery, creation, work, technology, process, method, reduction to practice, data, code, device, design, application, implementation, concept, practice, or idea, whether novel, original, or new or whether an improvement to, derivative work or derivation from, or amendment or modification to any existing any invention, development, discovery, creation, work, technology, process, method, reduction to practice, data, code, device, design, application, implementation, concept, practice, or idea, and any and all written and other tangible, and any and all electronic, copies, manifestations, and/or reflections thereof.

1.31 “Quarter” means, with regard to any Year, any one of the four periods of three (3) consecutive calendar months each that comprise such Year.

1.32 “R&D Development Plan” means the research and development plan prepared by BAT and delivered to 22nd Century.

1.33 “Reynolds Affiliate” means individually, and “Reynolds Affiliates” means collectively, any corporation, company or other entity in which Reynolds American Inc. owns, directly or indirectly, at least thirty percent (30%) of the voting securities.

1.34 “Reynolds” means Reynolds American Inc. and/or any Reynolds Affiliate.

1.35 “Research Materials” means any plants, harvested plant parts, seeds, cell lines, strains, genes, DNA, nucleic acid sequences and/or other tangible biological materials, but excluding seeds containing BAT commercial germplasm, covered by the Patent Rights and produced during the development of a Commercial Licensed Product by or on behalf of BAT or any BAT Affiliate.

1.36 “Research Purposes” means solely for BAT’s and/or any BAT Affiliate’s own research and product development purposes, and does not include the manufacture of commercial products for their commercial sale.

1.37 “Research Results” means, collectively all, and “Research Result” means individually any, Property resulting or arising from or in connection with, or as a result of, any research, development, or other activities under this Agreement related to validation of the patent claims of the Patent Rights.

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1.38 “Second Commercial Term” means the period of time from expiration of the First Commercial Term and extending until September 30, 2028.

1.39 “Section” means any of the numbered sections under any Article.

1.40 “Term” means the duration of this Agreement from the Option Effective Date until the date on which the expiration, termination, or cancellation of this Agreement becomes effective.

1.41 “Territory” means the entire world.

1.42 “Third Commercial Term” means the period of time from expiration of the Second Commercial Term and extending until expiration of the Commercial Term.

1.43 “Year” means any period of time that: (i) commences on the Option Effective Date and ends on the end of the calendar day immediately preceding the first anniversary of the First Day, or (ii) commences on any anniversary of the First Day and ends on the end of the calendar day immediately preceding the next following anniversary of the First Day.

1.44 Certain other defined terms have the meanings given them elsewhere in this Agreement.

ARTICLE 2 – COMMERCIAL LICENSE

2.01 Commercial License Grant . Subject to the terms and conditions of this Agreement (including, without limitation, Section 2.02), 22nd Century grants to BAT, and BAT accepts from 22nd Century, (i) an exclusive (except solely as provided in Section 2.05) license to use, make and grow Licensed Products and import, export, distribute, sell and offer for sale Commercial Licensed Products in the Territory (except that BAT may use, make, grow, import, export, distribute, sell and offer for sale, for commercial purposes, Commercial Licensed Products in the United States of America only through the sublicense right under clause (iv) of this Section 2.01) and the Field of Use during the Co-exclusive Term, (ii) a non-exclusive license to use, make and grow Licensed Products and import, export, distribute, sell and offer for sale Commercial Licensed Products in the Territory (except that BAT may use, make, grow, import, export, distribute, sell and offer for sale, for commercial purposes, Commercial Licensed Products in the United States of America only through the sublicense right under clause (iv) of this Section 2.01) and the Field of Use during the Non-exclusive Term, (iii) a non-exclusive worldwide license throughout the Territory to practice the Licensed Intellectual Property Rights for Research Purposes within the Field of Use during the Commercial Term (the foregoing collectively the “Commercial License”), and (iv) the right to sublicense solely Reynolds to use, make, grow, import, export, distribute, sell and offer for sale, for commercial purposes, Commercial Licensed Products in the United States of America and the Field of Use during the Commercial Term.

For the avoidance of doubt, any Licensed Product that is not destroyed shall only be used by BAT or a BAT Affiliate for

- 36 -

processing in a BAT leaf processing facility for conversion of such tobacco leaf into a tobacco leaf packaged product which will or is intended to ultimately become a Commercial Licensed Product Available for Shipment, or solely for research or other non-commercial purposes.

2.02 End of Commercial Term . Unless this Agreement terminates earlier for any reason, u pon the expiration of the Commercial Term, all licenses and all other rights granted by 22nd Century to BAT under this Agreement shall become and be and remain a perpetual, worldwide, fully-paid-up (with no further obligation by BAT or any BAT Affiliate or any third party for any exercise of any right of BAT under this Agreement to make any payment to 22nd Century or any 22nd Century Affiliate), irrevocable, transferable, assignable, sublicenseable, and non-exclusive license to use, make, grow, import, export, distribute, sell and offer for sale any Licensed Products in the Field of Use anywhere in the Territory (without, for the avoidance of doubt, the limitations under Section 2.01 or Section 2.03 regarding the United States of America) and either Party may use, practice, and exercise any Licensed Intellectual Property Rights for Research Purposes within the Field of Use, and either Party may freely grant direct and indirect sublicenses and rights to sublicense under all remaining Licensed Intellectual Property Rights in and outside the United States to any person or entity, as decided by such Party in its sole discretion.

2.03 Sublicensing BAT Affiliates . BAT has the unrestricted right to, and may as it decides in its sole discretion, sublicense, and grant the right to sublicense, BAT’s rights under the Commercial License to any BAT Affiliate in the Territory (other than in the United States of America). BAT has the unrestricted right to, and may as it decides in its sole discretion, sublicense BAT’s rights under the Commercial License in the United States of America solely to Reynolds, so long as Reynolds is a BAT Affiliate, for Reynolds to exercise in the United States of America as Reynolds decides in Reynolds’ sole discretion. Any such sublicense shall be in compliance with this Agreement relating to the Commercial License and such BAT Affiliates’ activities under such sublicense shall be subject to all the obligations of BAT under this Agreement related thereto (provided that BAT shall be responsible for any and all payments owed or due to 22nd Century under this Agreement for the actions of such BAT Affiliates). Subject to the sublicensing right under Section 2.04, such sublicense may not include the right to further sublicense or the right to enforce any Patent Rights without the prior written consent of 22nd Century other than any sublicense to any other BAT Affiliate (subject to the limitations expressly set forth in this Section 2.03 in the United States of America). BAT shall be responsible and liable for the performance of such sublicensed BAT Affiliates insofar as performance is required to or does fulfill any of BAT’s obligations and limitations under this Agreement, including without limitation the payment of all fees and royalties due 22nd Century and rights to Commercial Seeds, and an activity of such BAT Affiliate that, if such activity had been performed by BAT, would be an activity under this Agreement shall be deemed to be an activity of BAT. All such sublicense agreements shall automatically terminate upon termination of this Agreement or upon such entity no longer being a BAT Affiliate.

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[*] = CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION.

2.04 Sublicensing BAT Suppliers . BAT may sublicense the right to grow and process Licensed Products into Commercial Licensed Products under the Commercial License to BAT Suppliers. Any such sublicense shall be in writing and in compliance with the terms of this Agreement relating to the Commercial License (provided that no payment shall be owed or due to 22nd Century or a 22nd Century Affiliate under this Agreement by any BAT Supplier). Any such sublicense agreement shall not include the right to further sublicense or the right to enforce any Patent Rights without the prior written consent of 22nd Century. BAT shall be responsible and liable for the performance of such sublicensed BAT Suppliers insofar as performance is required to or does fulfill any of BAT’s obligations and limitations under this Agreement, and an activity of such BAT Supplier that, if such activity had been performed by BAT, would be an activity under this Agreement shall be deemed to be an activity of BAT. All such sublicense agreements shall automatically terminate upon termination of this Agreement.

2.05 Retention of Rights by 22nd Century .

(a) Notwithstanding any other provision of this Agreement, subject to the provisions set forth in Section 2.05(b), 22nd Century and 22nd Century Affiliates shall retain the right to practice the Patent Rights and Licensed Intellectual Property worldwide solely for research (but not commercial) purposes in the Field of Use during the Commercial Term, but no research or development that benefits directly or indirectly any Competitor Party; provided, however, that nothing in this Section 2.05(a) shall limit 22nd Century rights outside the Field of Use, 22nd Century’s right to commercialize 22nd Century Products pursuant to Section 2.05(c), and/or 22nd Century’s right to sublicense pursuant to Section 2.07.

(b) 22nd Century and 22nd Century Affiliates may have any research permitted under Section 2.05(a) performed by a Permitted Researcher only in accordance with, and shall cause such Permitted Researcher to comply with and perform in accordance with, the Permitted Researcher Agreement of such Permitted Researcher. [*].

(c) 22nd Century and 22nd Century Product Affiliates shall retain the worldwide right in the Field of Use to make, have made, grow, have grown, import, export, distribute, sell, offer to sell and otherwise engage in commercialization of solely Licensed Products that are 22nd Century Products during the Commercial Term.

(d) 22nd Century shall be responsible for the performance of the 22nd Century Affiliates and the contractors and subcontractors of 22nd Century and 22nd Century Affiliates insofar as performance is required to fulfill any of 22nd Century’s obligations and limitations under this Agreement. An activity of such a contractor or subcontractor that, if such activity had been performed by 22nd Century, would be an activity under this Agreement shall be deemed to be an activity of 22nd Century.

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2.07 Sublicensing Third Parties . During the Non-exclusive Term, but not before, 22nd Century may license, and BAT may sublicense third parties (other than BAT Affiliates), in the Field of Use as follows:

(a) Subject to BAT’s payment obligations under Section 3.08, BAT has the unrestricted right to, and may, grant any sublicense under the Commercial License in the Territory (other than the United States of America) to any third party. Any such license granted by BAT shall be in writing and be expressly subject to the rights of 22nd Century under this Agreement. BAT shall provide 22nd Century a copy of each such third party license agreement within thirty (30) days after execution of the subject license agreement. BAT shall be responsible and liable for the performance of its sublicensee(s) insofar as performance is required to or does fulfill any of BAT’s obligations and limitations under this Agreement. Any sublicense shall not include the right to further sublicense or the right to enforce any Patent Rights without the prior written consent of 22nd Century. BAT shall be responsible and liable for the performance of any such sublicensee insofar as performance is required to or does fulfill any of BAT’s or any such sublicensee’s obligations and limitations under this Agreement. All such sublicense agreements shall automatically terminate upon termination of this Agreement.

(b) Subject to 22nd Century’s payment obligations under Section 3.08, 22nd Century may license the Licensed Intellectual Property Rights worldwide in the Field of Use to third parties. Any such license granted by 22nd Century shall be in writing and be expressly subject to the rights of BAT under this Agreement. 22nd Century shall provide BAT a copy of each such third party license agreement within thirty (30) days after execution of the subject license agreement. 22nd Century shall be responsible and liable for the performance of its licensee(s) insofar as performance is required to or does fulfill any of 22nd Century’s obligations and limitations under this Agreement.

2.08 Limitations . Other than as provided in Sections 2.03, 2.04, and 2.07, the Commercial License does not include the right to grant sublicenses or any other right to sublicense under the Commercial License to any third party without the prior written consent of 22nd Century. For the avoidance of doubt, Reynolds is the only entity to which BAT may sublicense any rights under the Commercial License for use in the United States of America. Other than as expressly set forth in Sections 2.05, 2.06 and 2.07, neither 22nd Century nor 22nd Century Affiliate has or shall have any right, and no rights may be extended, licensed, assigned, or transferred to any third party, in any way, under the Licensed Intellectual Property Rights, in the Field of Use.

ARTICLE 3 – Royalties

3.01 Royalties . During the Full Term, BAT agrees to pay (i) such of the Pilot Royalties under Section 3.02 and the Running Royalties under Section 3.03 that are owed and due by BAT to 22nd Century under the terms and conditions of this Article 3 (collectively, “Royalties”) and (ii) such share of BAT Sublicense Profit set forth in Section 3.09. Other than as expressly provided elsewhere in this Agreement, no other payments are owed or due from BAT on behalf of BAT, any BAT Affiliates, or any third party sublicensee(s) of BAT. BAT will make the payment of any Royalties due to 22nd Century under this Article 3 pursuant to the wire transfer instructions provided to BAT by 22nd Century on or prior to the Option Effective Date or such different wire instructions provided to BAT by 22nd Century by written notice.

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3.02 Pilot Term Royalties . BAT shall pay 22nd Century a lump-sum royalty of one million U.S. Dollars (US$1,000,000.00) for the first Year of the Pilot Term and a lump-sum royalty of two million U.S. Dollars (US$2,000,000.00) for the second Year of the Pilot Term (the “Pilot Term Royalties”). The aforementioned one million U.S. Dollar (US$1,000,000.00) payment for the first Year of the Pilot Term shall be paid within thirty (30) days of the Option Effective Date. The aforementioned two million U.S. Dollar (US$2,000,000.00) royalty payment for the second Year of the Pilot Term shall be due within thirty (30) days after the beginning of such second Year of the Pilot Term. During the Pilot Term, BAT and BAT Affiliates may not stockpile more than sixty thousand (60,000) metric tonnes of Commercial Licensed Products that are Available for Shipment.

3.03 Running Royalties . During the Full Term, subject to the provisions in Sections 3.05, 3.06, and 3.07, BAT shall pay to 22nd Century a royalty at the Royalty Rate (as defined in Section 3.04) for all Commercial Licensed Products that are, and which royalty shall accrue when Commercial Licensed Products are, Available for Shipment (the “Running Royalties”); provided, however, that, subject to the Annual Royalty Limits pursuant to Section 3.07 and the credits pursuant to Section 3.06, the aggregate amount of the Running Royalties owed and due by BAT to 22nd Century for:

(i)

each Year during the First Commercial Term shall be the greater of (aa) the Running Royalties accrued and due for all Commercial Licensed Products that are Available for Shipment during such Year or (bb) the amount of the Minimum Annual Running Royalty for the First Commercial Term pursuant to Section 3.05; and

(ii)

each Year during the Second Commercial Term shall be the greater of (aa) the Running Royalties accrued and due for all Commercial Licensed Products that are Available for Shipment during such Year or (bb) the amount of the Minimum Annual Running Royalty for the Second Commercial Term pursuant to Section 3.05.

No Minimum Annual Royalties shall exist for any time after the Second Commercial Term. All Running Royalties due under this Agreement and accrued during a Quarter shall be due and payable for such Quarter within thirty (30) days following the end of such Quarter during the Full Term. If and to the extent that, at the end of a Year, the aggregate amount of all such Running Royalties for such Year is less than the Minimum Annual Running Royalty for such Year (the “Royalty Difference”), BAT shall pay 22nd Century the Royalty Difference within thirty (30) days after the end of such Year.

3.04 Royalty Rate . The term “Royalty Rate” means either of the following: (i) two hundred U.S. Dollars (US$200.00) per metric tonne of solely such Commercial Licensed Products supplied by BAT or a BAT Affiliate to Reynolds, or grown and processed by Reynolds if and to the extent, and only if and to the extent, such Commercial Licensed Products are, notwithstanding the location of where they were made Available for Shipment, used in a consumer product offered for sale and sold in the United States of America, or (ii) for all other Commercial Licensed Products (but not for any Commercial Licensed Product subject to Section 3.04(i)), one hundred U.S. Dollars (US$100.00) per full metric tonne, in each case adjusted for inflation as provided in Section 3.08.

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3.05 Minimum Annual Running Royalty . The term “Minimum Annual Running Royalty” means: (i) for each Year during the First Commercial Term, an amount of three million U.S. Dollars (US$3,000,000.00), adjusted for inflation as provided in Section 3.08, and (ii) for each Year during the Second Commercial Term, an amount of five million U.S. Dollars (US$5,000,000.00), adjusted for inflation as provided in Section 3.08. For the determination of the Royalty Difference under Section 3.03, Running Royalties for BAT Excluded Products shall not be counted in such calculation; all other Running Royalties shall be counted in such calculation. The Minimum Annual Running Royalty shall be paid on a Quarterly basis.

3.06 Credits . Any Royalty Difference under Section 3.03 for a Year may be credited against any future Running Royalties, provided that, for any Year during the First Commercial Term and Second Commercial Term, 22nd Century shall be entitled to not less than the Minimum Annual Running Royalty and any Royalty Difference accrued for such Year and not used as a credit shall accumulate until all of the accumulated Royalty Difference has been used as a credit against Running Royalties during the First Commercial Term, the Second Commercial Term, or the Third Commercial Term. Simply as an example, the chart as set forth in APPENDIX C is provided as an illustration of the application of the credits and Minimum Annual Running Royalty.

3.07 Annual Royalty Limits . During the Full Term, the annual cumulative Running Royalties due under this Agreement shall be capped for a given Year at the amount set forth in the following provisions of this Section 3.07 for such Year; provided that, for the purpose of determining whether such cap has been reached during a given Year, all Running Royalties for Commercial Licensed Products that are BAT Excluded Products or that are made Available for Shipment by BAT or a BAT Affiliate to a BAT Excluded Business shall not be counted in such calculation:

(a) For each Year during the First Commercial Term, such cap on the Running Royalties shall be fifteen million U.S. Dollars (US$15,000,000.00), adjusted for inflation as provided in Section 3.08, and

(b) For each Year during the Second Commercial Term and for each Year during the Third Commercial Term, such cap on the Running Royalties shall be twenty five million dollars (US$25,000,000.00), adjusted for inflation as provided in Section 3.08 (collectively, the “Annual Royalty Limits”).

3.08 Inflation Adjustment . Beginning in the year 2021, and every three (3) years thereafter, the Royalty Rate in Section 3.04, the Minimum Annual Running Royalty in Section 3.05 and the Annual Royalty Limits in Section 3.07 shall each be adjusted for inflation as follows:

Minimum Annual Running Royalty = ((prior Minimum Annual Running Royalty) x (cumulative CPI percentage increase since the last adjustment)) + (prior Minimum Annual Running Royalty).

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Annual Royalty Limit = ((prior Annual Royalty Limit) x (cumulative CPI percentage increase since the last adjustment)) + (prior Annual Royalty Limit).

Royalty Rate = ((prior Royalty Rate) x (cumulative CPI percentage increase since the last adjustment)) + (prior Royalty Rate).

For example, the CPI in 2017 will be compared to the CPI in 2020 and the amount for years 2021 through 2023 shall be increased by the percentage difference. Further, for 2024 through 2026, the CPI in 2020 will be compared with to the CPI in 2023 and the amount for years 2024 through 2026 will be increased by the percentage difference , and so on .

“CPI” means the Local Metropolitan Area Consumer Price Index published by the Bureau of Labor Statistics of the United States Department of Labor for Urban Wage Earners and Clerical Workers. In the event the Consumer Price Index is converted to a different standard reference base or otherwise revised, the determination of Adjusted royalty will be made with the use of such conversion factor, formula or table for converting the Consumer Price Index as may be published by the Bureau of Labor Statistics, or if the Bureau should fail to publish same, then with the use of such conversion factor, formula or table for converting the Consumer Price Index as may be published by Prentice Hall, Inc., or any other nationally recognized publisher of similar statistical information. If the Consumer Price Index ceases to be published and there is no successor thereto, such other index as Licensor and BAT may agree upon will be substituted for the Consumer Price Index.

3.09 Other Income . BAT and 22nd Century shall share sublicensing or licensing revenue as follows:

(a) BAT shall pay to 22nd Century fifty percent (50%) of any and all sublicense profits received by BAT or a BAT Affiliate from a third party sublicensee (other than a BAT Affiliate) outside the United States of America under a permitted sublicense of BAT or such BAT Affiliate with such third party sublicensee during the Non-exclusive Term, or at any time if and to the extent such sublicense is legally required to such a third party (collectively, “BAT Sublicense Profit”). BAT Sublicense Profit shall include such payments that are made by such third party sublicensee to BAT or such BAT Affiliate in consideration for such sublicense, but shall exclude any amounts for which BAT may be required to pay any royalty amount to 22nd Century under this Article 3. The definition of profits received by BAT or a BAT Affiliate from a third party sublicensee under this Section 3.09 shall mean gross revenue (including without limitation royalties, sublicensing fees, option fees, bonuses, research fees, milestone payments and advances) minus out-of-pocket costs and expenses directly incurred and paid in negotiating such sublicensing and any ongoing direct cost for servicing such sublicense and any audit costs (which for the avoidance of doubt does not include any overhead amounts) and such amounts which are required to be paid to the respective licensors of 22nd Century and/or BAT.

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(b) 22nd Century shall pay to BAT fifty percent (50%) of any and all license and sublicense profits received by 22nd Century or a 22nd Century Affiliate from a third party licensee and/or sublicensee (other than a 22nd Century Affiliate) under a permitted license and/or sublicense of 22nd Century or such 22nd Century Affiliate with such third party licensee and/or sublicensee during the Non-exclusive Term (including, without limitation, any arising from any revenue by such third party for any direct or indirect further sublicenses granted by such third party), or at any time if and to the extent such sublicense is legally required to such a third party (collectively, “22nd Century License Income”). The definition of profits received by 22nd Century or a 22nd Century Affiliate from a third party sublicensee under this Section 3.09 shall mean gross revenue (including without limitation royalties, sublicensing fees, option fees, bonuses, research fees, milestone payments and advances) minus out-of-pocket costs and expenses directly incurred and paid in negotiating such sublicensing and any ongoing direct cost for servicing such sublicense and any audit costs (which for the avoidance of doubt does not include any overhead amounts) and such amounts which 22nd Century is required to pay to its third party licensors.

(c) At the end of each Year, BAT shall deliver a written report to 22nd Century setting forth all BAT Sublicense Profit during such Year and pay to 22nd Century fifty percent (50%) of such BAT Sublicense Profit within sixty (60) days of the end of such Year. At the end of each Year, 22nd Century shall deliver a written report to BAT setting forth all 22nd Century License Income during such Year and pay to BAT fifty percent (50%) of such 22nd Century License Income within sixty (60) days of the end of such Year.

(d) It is also agreed that BAT and 22nd Century shall not receive anything of value in lieu of cash payments in consideration for any sublicense to a third party whose sublicense fees would count as BAT Sublicense Profit or 22nd Century License Income, as applicable, under this Section 3.09 without the prior written permission of the other Party.

3.10 Records, Royalty Statements and Reports . BAT and 22nd Century must keep, and shall cause each of their Affiliates with regard to any transactions subject to Running Royalties by BAT or payments under Section 3.09 to keep, full, true and accurate books of accounts and other records containing all particulars necessary to properly ascertain and verify the amounts payable to the other Party hereunder. These books of account must be kept at the applicable party’s principal place of business for a minimum of five (5) years following the end of the calendar year to which they pertain. All payments due under this Agreement shall be accompanied by a written statement setting forth in detail the basis for such payment.

3.11 Audit . 22nd Century and BAT each shall have the right, from time to time and at reasonable times during normal business hours, through an independent certified public accounting firm, to examine and verify the records of the other Party or licensed Affiliates of such other Party under this Agreement, and sublicensee(s) under this Agreement in order to verify the calculation of any Running Royalties, 22nd Century License Income, BAT Sublicense Income, and/or other fees and amounts payable under this Agreement. Such examination and verification shall not occur more than once every two years. If any such examination and verification reveals an underpayment by any Parties of more than 5% for any calendar quarter examined, the party being examined shall immediately pay the other applicable Party the amount of such underpayment plus interest (in accordance with Section 3.14) and shall reimburse the other applicable Party for all reasonable expenses incurred in the examination and verification of the records by the independent certified public accounting firm.

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3.12 Invalidity or Unenforceability of any of Patent Rights . Any of the foregoing notwithstanding, if, at any time during the Commercial Term, any of the Patent Rights are held invalid or unenforceable in a decision which is not appealable or is not appealed within the time allowed, BAT does not have a damage claim or a claim for refund or reimbursement against 22nd Century, but if such invalidity or unenforceability is of the last of the Patent Rights, no further Running Royalties or other payment shall be due for any time after such invalidity or unenforceability.

3.13 Taxes . Each Party shall deduct from any royalty or other payments to the other Party under this Agreement the appropriate amount of any withholding tax, duty, or other charges imposed under applicable law, and required to be paid under applicable law, to a government on such royalty or other payment under this Agreement, provided that such Party shall take reasonable steps within such applicable law to reduce or eliminate any such withholding requirement. In no event shall a Party be liable or responsible for, and the other Party shall indemnify and hold harmless such Party, for any amount of any tax assessed or due on any income of such other Party from any payment under this Agreement to such other Party.

3.14 Currency and Interest . All payments made to 22nd Century under this Agreement shall be paid in United States Dollars by wire transfer to a United States Dollar account designated by 22nd Century, consistent with all applicable laws and regulations. Any payment owed and due by a Party to the other Party under this Agreement and not paid to such other Party within thirty (30) days after the date on which such payment became due shall bear interest until payment at a rate of one percent (1%) for each full calendar month. The expiration or termination of this Agreement does not relieve a Party of its financial obligations to the other Party which have accrued and become due hereunder prior to the date of such expiration or termination. Each Party (the “Payor”) may offset or deduct from, or set off against, any payment owed by the Payor to the other Party (the “Payee”) any undisputed amount that the Payee owes to the Payor if and to the extent that such amount is undisputedly owed and due to the Payor under this Agreement. The Payor shall provide the Payee with written notice of the offset, deduction, or set-off (identifying the cause and sum of both the amount owed by the Payee and the payment from which such amount is offset or deducted or against which it is set off) at the time the remaining payment owed by the Payor is made or, if no part of such payment is remaining, at the time such payment would have had to be made. Any such undisputed offset, deduction, or set-off of any amount by the Payor shall satisfy the obligation of the Payor to pay such amount as if such amount had been paid by the Payor to the Payee.

ARTICLE 4 – FURTHER DEVELOPMENTS

4.01 Further Research Materials . During the Commercial Term, subject to BAT’s ownership thereof and Article 9, BAT shall deliver to and upon request by 22nd Century a reasonable number of samples of Research Materials created by and/or in the possession or control of BAT or any BAT Affiliates under this Agreement. For the avoidance of doubt, BAT shall not be required to provide to 22nd Century any seeds containing BAT commercial germplasm.

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4.02 Commercial Seed Supply . Following the commercialization by BAT or any BAT Affiliate of any Commercial Licensed Product, upon 22nd Century’s written request during the Commercial Term, and for a period of time of four (4) years following the expiration or early termination of the Commercial License for any reason, BAT shall sell to 22nd Century requested quantities of male sterile seeds for each tobacco variety requested by 22nd Century (the “Commercial Seed”) on commercially reasonable terms for use in commercializing 22nd Century’s and/or 22nd Century Affiliates’ wholly owned products and brands. For the avoidance of doubt, nothing in this Section 4.02 shall require BAT to exhaust its supply of Commercial Seed of any tobacco variety.

4.03 Further Research Results . BAT or BAT Affiliates shall solely own any and all rights, title, and interest in and to any and all Research Results and Property, and all proprietary rights therein and thereto, arising from or in connection with, or as a result of, any research, development, or other activities by or for BAT or any BAT Affiliate or any research, development, or other activities fully or partially funded by BAT or any BAT Affiliate (no matter who is the inventor, author, or other creator) during the Term related to, or that have application in, the Field of Use or otherwise, including, without limitation, any improvements, derivative works, modifications, or enhancements to or of or from or based on any the Licensed Intellectual Property Rights (together “Further Research Results”). 22nd Century shall, and shall cause any 22nd Affiliate or any employee of 22nd Century or a 22nd Century Affiliate to, execute any assignment or other document, and take any other action reasonably requested by BAT to implement and effect the foregoing provisions.

For the avoidance of doubt, during the Commercial Term

(i)

BAT shall not be required to provide to 22nd Century any seeds containing BAT commercial germplasm; and

(ii)

nothing in this Section 4.03 shall be construed as to grant BAT ownership rights in any Research Results or Property, or any proprietary rights therein or thereto, including without limitation any improvements, modifications, or enhancements covered by the Licensed Intellectual Property Rights, arising from or in connection with, or as a result of,

(aa)

any research, development, or other activities by, or by a third party (other than a BAT Affiliate) for, 22nd Century or any 22nd Century Affiliate, or

(bb)

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4.04 License to Further Research Results . BAT hereby grants to 22nd Century a non-exclusive, non-transferable, non-assignable, non-sublicensable, worldwide license to any and all registered Further Research Results owned by BAT during the Term to develop and commercialize 22nd Century Products. Such license shall be effective at 22nd Century’s election in 22nd Century’s sole discretion and shall be on commercially reasonable terms negotiated in good faith, including, without limitation, a limited duration, an arm’s length royalty, performance obligations, and no warranty, representation, covenant, indemnity, or comfort from BAT regarding validity, enforceability, non-infringement, or risk of third party claims regarding infringement or misappropriation relating to such intellectual property rights, but otherwise in no case on terms more onerous than the terms of the Commercial License granted to BAT under this Agreement. In the event BAT terminates the Commercial License, BAT shall provide 22nd Century with the details of any registered Further Research Results then in existence to the extent that 22nd Century is not already aware of such Research Results, subject to compliance with Article 10.

ARTICLE 5 – TERMINATION

5.01 Termination by BAT . BAT may terminate this Agreement at any time during the Term and at BAT’s sole discretion (without cause) by giving 22nd Century written notice at least thirty (30) days prior to such termination. It is understood that BAT will remain responsible for all monetary payments or other obligations which accrued and became due prior to the effective date of termination.

5.02 No Payment . In the event that BAT terminates this Agreement, no payment shall be owed or due other than any Pilot Royalties, Running Royalties, or other payments under this Agreement accrued, owed, and due prior to the effective date of such termination.

5.03 Termination by 22nd Century . Subject to Section 5.05, 22nd Century shall have the right to terminate this Agreement during the Term upon the occurrence of one or more of the following events:

(a) failure of BAT to make any payment required pursuant to this Agreement when due;

(b) failure of BAT to render reports to 22nd Century required by this Agreement;

(d) the material breach by BAT of any other material term of this Agreement.

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5.04 Notice of Breach and Right to Cure . In all cases of alleged breach by BAT of this Agreement entitling 22nd Century to terminate this Agreement under Section 5.03, 22nd Century must give BAT sixty (60) days’ prior written notice of such breach including the remedy sought, be it termination of this Agreement or another remedy (“Breach Notice”) . The Breach Notice must also specify the articles and sections of this Agreement which are claimed to have been breached and must contain a description of the event(s) or occurrence(s) claimed to constitute a breach. In all cases, BAT shall have sixty (60) days from the date of receipt of the Breach Notice to cure the alleged breach or in good faith to dispute the existence of a breach. If the claimed breach is cured within sixty (60) days, this Agreement shall not terminate. If BAT fails to cure the alleged breach by BAT within sixty (60) days of the Breach Notice , this Agreement shall terminate upon the expiration of the sixty (60) days, unless BAT initiates its arbitration rights against such termination under this Agreement, in which case the termination of this Agreement or another remedy related thereto will not be effective until a final unappealable decision in such proceeding has been rendered. Any Breach Notice shall not prejudice any Party’s rights and obligations under this Agreement, including without limitation, 22nd Century’s right to receive monetary sums due hereunder . If BAT fails to cure the alleged breach by BAT within sixty (60) days of the Breach Notice , this Agreement shall terminate upon the expiration of the sixty (60) days, unless BAT initiates arbitration against such termination under this Agreement, in which case the termination of this Agreement or another remedy related thereto will not be effective and will be subject to the following: (i) i f it is decided in a final unappealable or unappealed decision in such arbitration or an appeal thereof in accordance with Section 10.03 that the breach identified in such Breach Notice did not occur or did not entitle 22nd Century to a termination of this Agreement, or that the prerequisites of the termination do not exist, the termination shall be ineffective ab initio , or (ii) if it is decided in a final unappealable or unappealed decision in such arbitration or an appeal thereof in accordance with Section 10.03 that the breach identified in such Breach Notice occurred, that 22nd Century was entitled to the termination of this Agreement for such breach, and that the prerequisites of such termination exist, BAT shall have the right to cure such breach within thirty (30) days of receiving such decision, in which case the termination shall be ineffective, or absent such cure shall become effective at the end of such thirty (30) day period . Any Breach Notice shall not prejudice any Party’s rights and obligations under this Agreement, including without limitation, 22nd Century’s or BAT’s right to receive monetary sums due from the other Party hereunder.

ARTICLE 6 – PATENT PROSECUTION

6.01 Patent Prosecution . During the Commercial Term, 22nd Century shall prosecute and maintain all patents and patent applications of the Patent Rights. 22nd Century shall not abandon any patent application filed or issued patent in the Patent Rights without express prior written approval from BAT. Payment of all fees and costs relating to the filing, prosecution, and maintenance of the Patent Rights are ordinarily the responsibility of 22nd Century. However, 22nd Century shall take any additional lawful prosecution or maintenance activities related to the Patent Rights which BAT may reasonably request from time to time; provided, however, that BAT pays all costs and expense, including all reasonable attorneys’ fees, necessary for such activities.

6.02 Cooperation . BAT and 22nd Century agree to cooperate with each other in filing, prosecution, and maintenance of the Patent Rights. Upon the request of BAT, 22nd Century will provide copies by email to BAT and any agents of BAT of all patent office actions and 22nd Century’s responses to such office actions for the patent applications in Appendix B , plus any other applications that are part of the Patent Rights that may be filed. 22nd Century will give BAT the opportunity to offer comments and remarks thereon at BAT’s expense, such comments and remarks to be given due consideration by 22nd Century. However, notwithstanding anything to the contrary in this Agreement, all decisions with respect to the filing, prosecution, and maintenance of Patent Rights are reserved solely to 22nd Century.

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ARTICLE 7 – INFRINGEMENT OF PATENT RIGHTS BY THIRD PARTIES

7.01 Notice of Infringement by Third Parties . Each of the Parties shall inform the other Party promptly in writing of any alleged infringement of which it becomes aware and of any available evidence of infringement by a third party of any patent within the Patent Rights.

7.02 BAT Enforcement Options . If, during the Term, BAT becomes aware of any alleged infringement by a third party in the Territory, BAT has the right, but not the obligation, to either:

7.03 Enforcement by BAT . If BAT undertakes the enforcement and/or defense of the Patent Rights and/or Plant Variety Rights by litigation, including any declaratory judgment action, the total cost of any such action commenced or defended solely by BAT shall be borne by BAT and BAT shall indemnify 22nd Century and any applicable licensor for any counter or cross-claim. Any recovery of damages by BAT as a result of such action will be applied first in satisfaction of any unreimbursed expenses and attorneys’ fees of BAT relating to the action, and second toward reimbursement of 22nd Century’s expenses, including attorneys’ fees, if any, relating to the action. The balance remaining from any such recovery shall be equally split between 22nd Century and BAT. BAT is entitled to settle any such litigation by agreement, consent, judgment, voluntary dismissal, or otherwise, but only with the prior written consent of 22nd Century and if it has no adverse effect on any consideration to be received by 22nd Century under this Agreement .

7.04 Enforcement by 22nd Century. If BAT does not institute legal action against the infringing activity within three (3) months of having been made aware of or notified thereof, 22nd Century has the right, but is not obligated, to prosecute at its own expense any such infringement of the Patent Rights and/or Plant Variety Rights. In furtherance of that right, 22nd Century may use the name of BAT as a party plaintiff in any such action. The total cost of any such infringement action commenced or defended solely by 22nd Century must be borne by 22nd Century. Any recovery by 22nd Century in such action will be applied first in satisfaction of any unreimbursed expenses and attorneys’ fees of 22nd Century relating to the action, and second toward reimbursement of BAT’s expenses, including attorneys’ fees, if any, relating to the action. The balance remaining from any such recovery belongs solely to 22nd Century.

7.05 Cooperation by the Parties . In any infringement suit instituted by either Party to enforce the Patent Rights and/or Plant Variety Rights, the other Party must, at the request and expense of the Party initiating such suit, cooperate in all respects and, to the extent possible, have its employees testify when requested and make available relevant records, papers, information, data, samples, specimens, and the like.

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7.06 Invalidity of any of Patent Rights and/or Plant Variety Rights . Any of the foregoing notwithstanding, if, at any time during the Term, any of the Patent Rights and/or Plant Variety Rights are held invalid or unenforceable in a decision which is not appealable or is not appealed within the time allowed, BAT does not have a damage claim or a claim for refund or reimbursement against 22nd Century, but if such invalidity or unenforceability is of the last of the Patent Rights, no further Running Royalties or other payments shall be due for any time after such invalidity or unenforceability.

7.07 Freedom to Operate Notice . Each Party to this Agreement will inform the other Party promptly in writing if it becomes aware that the Patent Rights and/or Plant Variety Rights may infringe any third party’s patent rights and/or plant variety rights.

ARTICLE 8 – REGULATORY APPROVALS, PUBLICATION AND EXPORT

8.01 Laws and Regulations of the U.S. This Agreement is subject to all United States laws and regulations controlling the export of technical data, computer software, laboratory prototypes and other commodities and technology. It is understood that 22nd Century is subject to United States laws and regulations controlling the export of technical data, computer software, laboratory prototypes and other commodities (including the Arms Export Control Act, as amended and the Export Administration Act of 1979).

8.02 Licenses and Authorizations . To the extent any third party or governmental licenses, approvals, or authorizations are required for BAT to use and exploit the Licensed Intellectual Property Rights as envisaged under the terms of this Agreement, it shall be the sole responsibility of BAT to obtain any and all such licenses, approvals, authorizations, technology or intellectual property at BAT’s sole cost and expense. To the extent any third party or governmental licenses, approvals, or authorizations are required for 22nd Century to use and exploit the Licensed Intellectual Property Rights as envisaged under the terms of this Agreement, it shall be the sole responsibility of 22nd Century to obtain any and all such licenses, approvals, authorizations, technology or intellectual property at 22nd Century’s sole cost and expense. Subject to, and without limiting any of, the provisions, rights, or obligations of a Party under this Agreement, neither Party shall be obligated to procure any right under or to any intellectual property right of any third party necessary for the other Party’s use or exploitation of any Licensed Intellectual Property Right.

ARTICLE 9 – CONFIDENTIALITY

9.01 Confidentiality . Each Party will each treat any Property disclosed to it (the “Receiving Party”) by the other Party (the “Disclosing Party”) with reasonable care and will not disclose such information to any other person, firm or corporation, except Affiliates and contractors of the Receiving Party bound by the obligations of confidentiality and restricted use set forth in this Article 11. Any Property the rights to which are owned under this Agreement by a Party shall be the confidential information of such Party, and such Party shall be deemed to be the Disclosing Party of such Property under this Agreement. The Receiving Party may not use the Disclosing Party’s confidential information other than for the benefit of the Parties and in the performance of this Agreement. These obligations of non-disclosure and restricted use remain in effect for each subject disclosure of confidential information while this Agreement is in effect and until the later of the date of termination of this Agreement or five (5) years from the date of disclosure. However, notwithstanding the foregoing, no Receiving Party is obligated, with respect to Property disclosed to it by the Disclosing Party, or any part thereof, which:

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(a) is already known to the Receiving Party at the time of the disclosure;

(b) becomes publicly known without the wrongful act or breach of this Agreement by the Receiving Party;

(d) is subsequently and independently developed by employees or contractors of the Receiving Party who had no knowledge of such Property, as verified by written records;

(e) if and to the extent and only as approved for release by prior written authorization of the Disclosing Party; or

9.02 Confidential Disclosures . The Parties agree that any Property to be treated as confidential information under this Article 11 must be disclosed in writing or in another tangible medium and must be clearly marked “CONFIDENTIAL” or the like. Property disclosed orally or visually that the Disclosing Party desires to keep confidential must be summarized and reduced to writing and communicated to the Receiving Party within thirty (30) days of such disclosure.

9.03 Exceptions of Confidential Disclosures . Notwithstanding the foregoing of this Article 10, the Parties may use and disclose any confidential information related to the Patent Rights to BAT Affiliates (if BAT) or 22nd Century Affiliates (if 22nd Century), to (if BAT or a BAT Affiliate) BAT Suppliers, or to potential sublicensees, prospective investors, employees, consultants and agents with a need to know, collaborators, prospective collaborators and other third parties in the chain of growing, manufacturing and distributing Licensed Products, but if and only if the applicable party obtains from each such recipient a written confidentiality agreement, the provisions of which are at least as protective of 22nd Century’s confidential information as those provided in this Article 10.

9.04 Confidentiality Related to Patent Rights . Notwithstanding anything to the contrary in this Agreement, all information relating to filing, prosecution, maintenance, defense, infringement, and the like regarding the Patent Rights (no matter how disclosed) is the confidential information of 22nd Century and subject to the provisions of this Article 10.

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ARTICLE 10 – GOVERNING LAW AND ARBITRATION

10.01 Governing Law . As the Parties will be doing business in different locations, and seek certainty in their dealings with each other and with third-parties, the Parties to this Agreement expressly acknowledge and agree that this Agreement, and the performance or breach thereof, shall be entered into, interpreted, governed, construed, and enforced in accordance with the substantive and procedural laws of the State of New York , United States of America, without regard to any choice of law principles. The Parties hereby irrevocably submit to the exclusive personal jurisdiction of the state and federal courts located in or serving the State of New York, United States of America, for the purposes of any claim, action or proceeding brought pursuant to or arising from this Agreement.

10.02 Injunctive Relief . Each Party agrees that the other Party’s remedies at law for any breach of its obligations of this Agreement (other than pure payment obligations) will or may be inadequate alone, and that such other Party shall be entitled to equitable relief, including, without limitation, injunctive relief and specific performance, in addition to any other available remedies it may have in law and in equity, and such Party hereby waives any requirement for security or posting of any bond in connection with any such remedy.

10.03 Arbitration . Any and all disputes arising out of or in connection with this Agreement, and/or any breach of this Agreement by BAT, any BAT Affiliates, 22nd Century, any 22nd Century Affiliates, any licensees and/or any sublicensees of the foregoing under this Agreement will be referred to and finally resolved by arbitration administered by the International Centre for Dispute Resolution in accordance with the International Arbitration Rules. Each Party shall be entitled to seek interim, interlocutory or permanent injunctive relief from any state or federal court located in the State of New York, United States of America, and the parties hereby agree to submit to the exclusive personal jurisdiction of the state and federal courts located in or serving the State of New York, United States of America, for the purposes of any claim, action or proceeding brought pursuant to or arising from this Agreement. The Parties agree that the arbitration proceedings will be conducted in New York City, State of New York, United States of America. The language of the proceedings and all results thereof shall be in English. All arbitration proceedings will be conducted before a single arbitrator selected by the relevant arbitration commission, provided that such arbitrator shall have experience in conducting business arbitration with respect to intellectual property licensing. The decision resulting from the arbitrator shall be final, not appealable except with respect to any point of law, and binding on the Parties and any judgment on the award rendered by the arbitrator may be entered in any court having jurisdiction.

ARTICLE 11 – NOTICES

11.01 Notices .

(a) All Notices (as defined in Section 11.02) by a Party to the other Party shall be sent to such other Party to at least the following address and attention of such other Party (or such other address and/or attention as such other Party has notified by written Notice to the Party sending the Notice at least thirty (30) days prior to such Notice):

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If to BAT:

British American Tobacco (Investments) Limited

Attention: Head of Marketing Legal

Globe House

4 Temple Place

London WC2R 2PG

United Kingdom

If to 22nd Century:

22nd Century Limited, LLC

Attention: Joseph Pandolfino

9530 Main Street

Clarence, New York 14031

United States of America

If to 22nd Century Group:

22nd Century Group, Inc.

Attention: Joseph Pandolfino

9530 Main Street

Clarence, New York 14031

United States of America

(b) A copy of any Notice sent to a Party under Section 12.01(a) shall be sent simultaneously to such Party to the following (whereby such copy shall not be deemed to be notice):

If such notice, demand, or written communication is to BAT, to each of the following:

(1) British American Tobacco (Investments) Limited

Attention: Head of Patents and Innovations

Globe House

4 Temple Place

London WC2R 2PG

United Kingdom

(2) By e-mail to:

(3) By e-mail to:

If such notice, demand, or written communication is to 22nd Century, to each of the following:

(1) 22nd Century Limited, LLC

Attention: Michael R. Moynihan, PhD

9530 Main Street

Clarence, New York 14031

United States of America

(2) By email to:

(3) By email to:

A copy of any Notice by 22nd Century to BAT under Section 1.19(iv) shall also be sent by 22nd Century simultaneously to:

by mail to:

British American Tobacco (Investments) Limited

Attention: Head of Group Research & Development [Cambridge]

210 Cambridge Science Park

Milton Road

Cambridge CB4 0WA

United Kingdom

and by e-mail to:

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11.02 Delivery . The Parties agree that any notice or demand sent by a Party to the other Party (including, without limitation, exercising the Option, notice of termination, notice of breach, notice of infringement, demand, notice under Section 1.15(iv), or any other notice resulting in a deadline or having legal consequences under this Agreement) (“Notice”) must be sent to such Party at the address and to the attention as stated for such Party in Section 11.01(a) by a reputable internationally recognized carrier with a delivery confirmation or tracking number (charges prepaid). The date on which any such Notice to a Party is deemed given to such Party shall be the date of the delivery by such internationally recognized carrier to such Party at the address and to the attention as set forth in Section 11.01(a) for such Party.

ARTICLE 12 – SUCCESSORS, ASSIGNMENT AND CHANGE OF CONTROL

12.01 Successors . This Agreement is binding upon and inures to the benefit of the respective successors and assigns of the Parties hereto.

12.02 No Assignments . This Agreement may not be transferred or assigned by either Party except: (i) that BAT may transfer or extend this Agreement to any BAT Affiliate (subject to a reasonable guaranty by BAT of such BAT Affiliate’s performance after such transfer), or (ii) that either Party may transfer this Agreement in connection with the sale or other transfer of such Party’s entire business, as the case may be, except in the event of a sale or other transfer by 22nd Century to a Competitor Party, in which case the provisions in Section 13.03 shall apply to the same extent as in the event of a change of control set forth therein. Any other assignment of this Agreement without the prior written consent of the other Party shall be null and void.

12.03 Change of Control . In the event a Competitor Party takes control of 22nd Century by obtaining more than fifty percent (50%) of the common stock of 22nd Century Group, Inc., BAT’s rights under this Agreement will be unaffected, but BAT’s obligations under this Agreement shall be amended automatically (without need for any notice or other action) and effective immediately upon such change of control as follows:

(a) the Royalty Rates set forth in Section 3.03 shall be reduced to fifty dollars ($50.00) per metric tonne for BAT and one hundred dollars ($100.00) per metric tonne for Reynolds;

(b) the Pilot Term Royalties due pursuant to Section 3.02 and the Minimum Annual Royalties due pursuant to Section 3.05 shall all be reduced by fifty percent (50%);

(d) BAT’s obligations in Sections 4.01, 4.03, and 4.04 shall terminate; and.

(e) BAT’s obligation to supply seed pursuant to Section 4.02 shall terminate.

All other provisions of this Agreement will remain unchanged.

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ARTICLE 13 – INDEMNITY, REPRESENTATIONS AND DISCLaimer

13.01 Indemnity .

(a) 22nd Century and 22nd Century Group shall indemnify, defend and hold harmless BAT, all BAT Affiliates, and each of its officers, directors, employees, agents, and licensors, and their respective successors and assigns (collectively, “BAT Indemnitee(s)”), by counsel selected by 22nd Century, from and against any claim, liability, cost, expense, demand, action, suit, proceeding, damages, judgment, penalty, deficiency, loss or obligation, of any kind or nature (including, without limitation, reasonable attorneys’ fees and other costs and expenses of defense) (collectively, “Claims”) based upon, arising out of, or otherwise relating, directly or indirectly, to any breach, or allegation giving rise to any breach, of any warranty or representation of 22nd Century under Section 13.02. A BAT Indemnitee shall provide 22nd Century with reasonably prompt written notice of such a Claim. 22nd Century shall have the right to compromise or settle such Claim; provided, however, that (i) no compromise or settlement of any such Claim may be effected by 22nd Century without the consent of BAT unless (i) there is no finding or admission of any violation of law or the rights of any person by a BAT Indemnitee, (ii) no such compromise or settlement has an adverse effect on any other claims that may be made by a BAT Indemnitee against 22nd Century, (iii) the sole remedy provided thereunder is monetary damages which will be paid in full by 22nd Century in accordance with such compromise or settlement and 22nd Century reasonably demonstrates its financial capacity to do so, and (iv) no such compromise or settlement has an adverse effect on any consideration to be received by BAT under this Agreement.

(b) BAT shall indemnify, defend and hold harmless 22nd Century, all 22nd Century Affiliates, and each of its officers, directors, employees, agents, and licensors, and their respective successors and assigns (collectively, “22nd Century Indemnitee(s)”), by counsel selected by BAT, from and against any claim, liability, cost, expense, demand, action, suit, proceeding, damages, judgment, penalty, deficiency, loss or obligation, of any kind or nature (including, without limitation, reasonable attorneys’ fees and other costs and expenses of defense) (collectively, “Claims”) of any third party (other than any BAT Affiliate or 22nd Century Affiliate) asserting any product liability claim against a 22nd Century Indemnitee arising from any tobacco developed by BAT funded activities under this Agreement which is grown, made, imported, exported, sold, offered for sale or used by or behalf of BAT or any BAT Affiliate and/or any Licensed Product which is grown, made, imported, exported, sold, offered for sale or used by or behalf of BAT or any BAT Affiliate. A 22nd Century Indemnitee shall provide BAT with reasonably prompt written notice of such a Claim. BAT shall have the right to compromise or settle such Claim; provided, however, that (i) no compromise or settlement of any such Claim may be effected by BAT without the consent of 22nd Century unless (i) there is no finding or admission of any violation of law or the rights of any person by a 22nd Century Indemnitee, (ii) no such compromise or settlement has an adverse effect on any other claims that may be made by a 22nd Century Indemnitee against BAT, (iii) the sole remedy provided thereunder is monetary damages which will be paid in full by BAT in accordance with such compromise or settlement and BAT reasonably demonstrates its financial capacity to do so, and (iv) no such compromise or settlement has an adverse effect on any consideration to be received by 22nd Century under this Agreement.

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13.02 Warranties and Representations of 22nd Century . 22nd Century warrants and represents that (a) as of the Effective Date of the Research License it either owns or is the exclusive worldwide licensee of the Patent Rights in the Field of Use, (b) it has the sole and unrestricted right to grant the Commercial License provided in this Agreement , (c) performance of its obligations under this Agreement does not and will not violate any existing agreement to which it is subject or a party, (d) the execution of this Agreement has been duly authorized and 22nd Century’s performance hereunder is within its corporate power, and (e) to 22nd Century’s knowledge, as of the date of signing the Research Agreement, the Patent Rights will not infringe any third party’s rights. 22nd Century warrants and represents that the wire transfer instructions supplied under Section 3.01 are and will remain correct, complete, and sufficient for BAT to make any payments under this Agreement to 22nd Century unless and until 22nd Century provides BAT written notice of different wire transfer instructions, in which case 22nd Century warrants and represents that such different wire transfer instructions are and will remain correct, complete, and sufficient for BAT to make any payments under this Agreement to 22nd Century

13.03 Warranties and Representations of BAT . BAT warrants and represents that (a) performance of its obligations under this Agreement does not and will not violate any existing agreement to which it is subject or a party, and (b) the execution of this Agreement has been duly authorized and its performance hereunder is within its corporate power.

13.04 Disclaimer . OTHER THAN AS PROVIDED IN SECTION 13.02 (FOR 22ND CENTURY) OR 13.03 (FOR BAT), NEITHER PARTY NOR ANY OF SUCH PARTY’S AFFILIATES MAKES ANY, AND ALL OF THEM DISCLAIM ALL, WARRANTIES, REPRESENTATIONS, AND CONDITIONS OF ANY KIND, EXPRESS OR IMPLIED OR LEGAL, INCLUDING, WITHOUT LIMITATION, ANY WARRANTIES, REPRESENTATIONS, OR CONDITIONS OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR WORKMANSHIP OR TITLE OR NON-INFRINGEMENT, NOR IS THERE A WARRANTY, REPRESENTATION, OR CONDITION THAT THE USE OF THE PATENT RIGHTS OR ANY FURTHER RESEARCH RESULT, PROPERTY, OR ACTIVITY OF THIS AGREEMENT WILL NOT INFRINGE ANY PATENT, COPYRIGHT, TRADEMARK OR OTHER RIGHTS. IN ADDITION, NOTHING IN THIS AGREEMENT MAY BE DEEMED TO BE A REPRESENTATION OR WARRANTY BY 22ND CENTURY OF THE VALIDITY OF ANY OF THE PATENTS OR THE ACCURACY, SAFETY, EFFICACY, OR USEFULNESS, FOR ANY PURPOSE, OF THE PATENT RIGHTS, OR ANY REPRESENTATION, WARRANTY, OR CONDITION BY BAT OR ANY BAT AFFILIATE OF THE VALIDITY, ACCURACY, SAFETY, EFFICACY, OR USEFULNESS, FOR ANY PURPOSE, OF ANY FURTHER RESEARCH RESULT. 22ND CENTURY HAS NO OBLIGATION, EXPRESS OR IMPLIED, TO SUPERVISE, MONITOR, REVIEW OR OTHERWISE ASSUME RESPONSIBILITY FOR THE PRODUCTION, MANUFACTURE, TESTING, MARKETING OR SALE OF ANY LICENSED PRODUCT BY BAT OR ITS AFFILIATES. 22ND CENTURY HAS NO LIABILITY WHATSOEVER TO BAT OR ANY THIRD PARTIES FOR OR ON ACCOUNT OF ANY INJURY, LOSS, OR DAMAGE, OF ANY KIND OR NATURE, SUSTAINED BY, OR ANY DAMAGE ASSESSED OR ASSERTED AGAINST, OR ANY OTHER LIABILITY INCURRED BY OR IMPOSED UPON BAT OR ANY OTHER PERSON OR ENTITY, ARISING OUT OF OR IN CONNECTION WITH OR RESULTING FROM THE USE OF THE PATENT RIGHTS BY BAT. IN NO EVENT SHALL EITHER PARTY BE LIABLE, REGARDLESS OF THE BASIS OR GROUND OF LIABILITY, FOR ANY INDIRECT, INCIDENTAL, CONSEQUENTIAL, EXEMPLARY, LIQUIDATED, SPECIAL, OR PUNITIVE DAMAGES OR LOSSES, INCLUDING, WITHOUT LIMITATION, LOST PROFITS AND LOST BUSINESS, WHETHER FORESEEABLE OR NOT, EVEN IF IT HAS BEEN ADVISED OF THE POSSIBILITY THEREOF, UNDER THIS AGREEMENT.

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ARTICLE 14 – BANKRUPTCY

14.01 Bankruptcy etc. of 22nd Century . To the greatest extent permissible under applicable law, none of the licenses and rights granted to BAT under this Agreement shall terminate, expire, be limited or restricted, or adversely modified or affected in the event that 22nd Century or any 22nd Century Affiliate, or any licensor thereof, ceases or fails to conduct business operations, takes steps to dissolve or cease to exist, files or is or becomes subject to a petition in bankruptcy (or similar reorganization proceeding), admits its inability to pay its debts as they become due, makes a general assignment for the benefit of its creditors, or becomes subject to the appointment of a receiver. This Agreement and the rights and licenses to BAT are subject to 11 U.S.C. § 365(n) and the right of BAT to elect retention of this Agreement and the licenses and rights to BAT hereunder if BAT so decides in its sole discretion. In the event of any bankruptcy or other such event as described above in this Section 14.01, to the greatest extent permissible under applicable law, 22nd Century will assert the continuation of any licenses granted to 22nd Century or any 22nd Affiliate and sublicensed to BAT under this Agreement. 22nd Century will further promptly engage in such acts as reasonably requested by BAT to 22nd Century to ensure BAT’s continued rights under the licenses granted by 22nd Century under this Agreement and/or BAT’s continued rights arising or flowing from any licenses granted to 22nd Century or 22nd Century and sublicensed to BAT under this Agreement under substantially the same terms as those in effect immediately prior to the bankruptcy or other such event as described above in this Section 14.01 .

14.02 Cooperation . If any of the events identified in Section 15.01 occurs or is likely to occur, 22nd Century shall promptly notify BAT thereof in writing and provide BAT with all information requested by BAT related thereto. In such case, if and to the extent legally permissible under applicable law, the Parties will cooperate with external legal and other advisers (each Party bearing its own cost related thereto) to identify the best option or options to protect BAT and BAT Affiliates’ access to the Licensed Intellectual Property Rights in or despite such event. 22nd Century agrees that, in any such event, it will undertake all as legally permissible under applicable law to ensure that none of BAT’s rights and licenses under this Agreement are terminated, limited, restricted, or adversely modified or affected.

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ARTICLE 15 – USE OF A PARTY'S NAME

15.01 Unless required by operation of law, rule or regulation, including without limitation any securities law, rule or regulation, or any binding judgment or court order or any requirement of a competent authority, neither 22nd Century nor any 22nd Century Affiliate may publish or disclose this Agreement, the existence of this Agreement, or any of the provisions of this Agreement (except: (i) if and to the extent expressly permitted by BAT in an advance written notice to 22nd Century, which shall be in BAT’s discretion, or (ii) to each other, or (iii) to any legal or financial consultant subject to an obligation of confidentiality regarding such disclosure or as necessary for, and in the course of, enforcing any of their rights under this Agreement), and none of the Parties may, without the prior written consent of the other applicable Party:

(b) use the name or image of any employee or agent of the other Party in any publication, publicity, advertising, press release, promotional activity or otherwise.

ARTICLE 16 – GUARANTY

16.01 22nd Century Group hereby guarantees to BAT the performance of any and all obligations, and any and all liability, of 22nd Century under this Agreement, including, without limitation, all payments owed and due by 22nd Century to BAT, to the same extent as if such obligations and liability were direct obligations and liabilities of 22nd Century Group to BAT. The guaranty in this Article 16 is an absolute, unconditional, and irrevocable continuing guaranty, which shall be effective as long as this Agreement is in effect, and thereafter with regard to any obligation or liability of 22nd Century that accrued before, or that survives, the termination, expiration, or cancellation of this Agreement until all such obligations and liabilities have been satisfied in full. 22nd Century Group hereby waives, relinquishes, and abandons any right to request, demand, or require BAT first to claim or pursue any right or remedy of any kind against 22nd Century for all or any part of any obligations or liability guaranteed by 22nd Century Group under this Article 16. 22nd Group hereby confirms and agrees that its obligations and liability under the guaranty in this Article 16 shall be in effect, enforceable, and not be waived, relinquished, or abandoned in the event of, any amendment or change of this Agreement. 22nd Century Group hereby waives notice of any amendment or change of this Agreement. Nothing in this Article 16 waives any right of any Party to assert, to bring any action for, or to enforce any right or remedy by such Party against the other or any direct obligation or liability of 22nd Century Group under Section 13.01(a).

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16.02 In the event 22nd Century Group no longer has any ownership interest in 22nd Century after the Effective Date, then 22nd Century Group may from and after that time request BAT to consent to the release of 22nd Century Group from the guaranty in this Article 16 and any obligation or liability of 22nd Century Group under Section 13.01(a), which consent BAT shall not unreasonably withhold, condition or delay as long as (i) the entity which then owns 22nd Century (“New Owner”) agrees in a written agreement with BAT to be bound by the guaranty in this Article 16 and any obligation or liability of 22nd Century Group under Section 13.01(a) to the full extent as set forth therein for 22nd Century Group, (ii) such entity is also of equal or greater financial strength as compared to 22nd Century Group at the time of such request, (iii) 22nd Century and 22nd Century Group provides to BAT all information reasonably necessary to assess the financial strength of New Owner (which provision of the last such information, 22nd Century and 22nd Century Group shall be deemed to warrant and represent that neither of them nor any 22nd Century Affiliate has any further such information), and (iv) 22nd Century shall pay, and 22 Century Group hereby guarantees under the same terms as set forth in Section 16.01, full payment of BAT’s reasonable legal expenses arising from the release of 22nd Century Group from the guaranty in this Article 16 and/or New Owner’s agreements under Section 16.02(i). BAT enters into this Agreement in reliance upon 22nd Century Group’s guaranty and the provisions in this Article 16.

ARTICLE 17 – SEVERANCE AND WAIVER

17.01 Severance . Each clause of this Agreement is a distinct and severable clause and if any clause is deemed illegal, void or unenforceable, the validity, legality or enforceability of any other clause or portion of this Agreement will not be affected.

17.02 Waiver . The failure of a Party in any instance to insist upon the strict performance of the terms of this Agreement is not a waiver or relinquishment of any of the terms of this Agreement, either at the time of the Party’s failure to insist upon strict performance or at any time in the future, and such terms will continue in full force and effect.

ARTICLE 18 – TITLES AND DRAFTING

18.01 Titles . All titles, section headings and article headings contained in this Agreement are inserted only as a matter of convenience and reference. They do not define, limit, extend or describe the scope of this Agreement or the intent of any of its provisions.

18.02 Drafting . For purposes of construing this Agreement, each of the Parties shall be deemed the drafter of this Agreement.

ARTICLE 19 – SURVIVAL OF TERMS

19.01 The provisions of Articles 1 (with regard to any definition used in any of the following surviving terms), 9, 10, 11, 13 (with regard to any Claim thereunder arising prior to the expiration or termination of this Agreement), 15, 16, 17, 18, and 20, this Article 19, and Section 4.03, shall survive the expiration or termination of this Agreement.

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ARTICLE 20 – ENTIRE UNDERSTANDING

20.01 This Agreement represents the entire understanding among the Parties, and supersedes all other agreements, express or implied, among the Parties concerning the subject matter hereof, and is not subject to any change or modification except by the execution of a written instrument subscribed to by authorized representatives of the Parties. Upon the Option Effective Date of this Agreement, the Research License Agreement shall terminate and expire, subject to any terms set forth in Article 18 of the Research License Agreement, which shall survive but only with regard to the time preceding such Option Effective Date.

[Signature page follows.]

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IN WITNESS WHEREOF , the Parties have executed this Agreement as of the Option Effective Date.

BAT:			22ND CENTURY:

British American Tobacco (Investments) Limited			22nd Century Limited, LLC

By:			By:
Name:			Name:
Title:			Title:

For the limited purpose of indemnity provided in Section 13.01(a) and Article 16:

22nd Century Group, Inc.

By:
Name:
Title:

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APPENDIX A

BAT AFFILIATES

( without limitation )

No.		Centre Corporate Companies
1		B.A.T (U.K. and Export) Ltd
2		B.A.T Capital Corporation (incorp. in the U.S.)
3		B.A.T. International Finance p.l.c.
4		BATMark Ltd.
5		British-American Tobacco (Holdings) Ltd.
6		British American Tobacco Holdings (The Netherlands) B.V.
7		British American Tobacco International Ltd. (incorp. in Switz.)
8		British American Tobacco (Brands) Inc. (incorp. in the U.S.)
9		British American Tobacco (Brands) Ltd.
10		British American Tobacco (GLP) Ltd.
11		British American Tobacco (Investments) Ltd.
		Asia-Pacific
12		British American Tobacco Australia Ltd.
13		British American Tobacco Bangladesh Company Ltd.
14		PT Bentoel Internasional Investama Tbk (Indonesia)
15		British American Tobacco Japan, Ltd.
16		British American Tobacco (Malaysia) Berhad
17		British American Tobacco (New Zealand) Ltd.
18		Pakistan Tobacco Co. Ltd.
19		British American Tobacco Korea Ltd.
20		British American Tobacco Korea Manufacturing Ltd.
21		B.A.T Services Ltd. (Taiwan, incorporated in the UK)
22		British-American Tobacco Marketing (Singapore)
		Americas
23		za-Piccardo S.A.I.C.y F. (Argentina)
24		Souza Cruz, S.A. (Brazil)
25		Imperial Tobacco Canada Ltd.
26		British American Tobacco Chile Operaciones, S.A.
27		British American Tobacco Colombia S.A.S.
28		British American Tobacco Mexico, S.A. de C.V.
29		C.A. Cigarrera Bigott Sucs. (Venezuela)
30		British American Tobacco Belgium S.A.
		Western Europe
31		British American Tobacco (Czech Republic), s.r.o.
32		British American Tobacco Denmark A/S
33		British American Tobacco France SAS
34		British-American Tobacco (Germany) GmbH
35		British American Tobacco (Industrie) GmbH
36		BAT Pecsi Dohnygyr Kft. (Hungary)
37		British American Tobacco Italia S.p.A.
38		British American Tobacco Nederland B.V.
39		British American Tobacco Western Europe Region B.V.
40		British-American Tobacco Polska S.A.
41		British American Tobacco Polska Trading sp. zo.o.
42		British-American Tobacco (Romania) Trading SRL
43		British American Tobacco España, S.A.
44		British American Tobacco Sweden AB
45		Fiedler & Lundgren AB
46		British American Tobacco Switzerland S.A.
47		British American Tobacco UK Ltd.
		Eastern Europe, Middle East and Africa
48		British American Tobacco (Algérie) S.P.A.
49		British American Tobacco Egypt LLC
50		B.A.T. Pars Company (Private Joint Stock) (Iran)
51		British American Tobacco Kazakhstan Trading LLP
52		British American Tobacco Exports B.V. (Morocco)
53		British American Tobacco (Nigeria) Ltd.
54		OJSC British American Tobacco – STF (Russia)
55		OJSC British American Tobacco – Yava (Russia)
56		CJSC British American Tobacco – SPb (Russia)
57		CJSC International Tobacco Marketing Services
58		B.A.T. Tobacco Holdings South Africa (Pty) Ltd
59		B.A.T. Tütün Mamulleri Sanayi ve Ticaret A.S. (Turkey)
60		A/T B.A.T. – Prilucky Tobacco Co. (Ukraine)

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Appendix B

PATENT RIGHTS

Patent Family

Country/
Region

No.

Application No.

Filing
Date

Patent No.

Date
Issued

Assignee

ARIPO

AP/P/2007/004181

2/28/06

22nd Century

Australia

2006233359

2/28/06

2006233359

7/19/12

22nd Century

2012203977

7/5/12

22nd Century

Canada

2599302

2/28/06

22nd Century

Reducing Levels of Nicotinic

China

200680010544.X

2/28/06

200680010544.X

9/5/12

22nd Century

Alkaloids in Plants

2012102520317

7/19/12

22nd Century

Hong Kong

13109543.8

8/15/13

22nd Century

PCT/IB2006/001741

Japan

P2007-557629

2/28/06

4892744

1/6/12

NAIST*

(WO2006109197)

Korea

2007-7022315

2/28/06

22nd Century

2013-7006598

3/14/13

22nd Century

Filed on 02-28-2006

Mexico

2007/010520

2/28/06

301367

7/16/12

22nd Century

2012/008279

7/16/12

305368

11/16/12

22nd Century

2012/013312

11/15/12

22nd Century

Philippines

1-2007-501841

2/28/06

22nd Century

South Africa

2007/08331

2/28/06

2007/08331

9/30/09

22nd Century

United States

11/579661

2/28/06

22nd Century

13/082953

4/8/11

22nd Century

Increasing Levels of

Europe

06848676.0

9/13/06

22nd Century

Nicotinic Alkaloids

11187201.6

10/28/11

22nd Century

Hong Kong

12110455.3

10/19/12

22nd Century

PCT/IB2006/004043

Japan

2009-537707

9/13/06

5087777

9/21/12

NAIST*

(WO2007072224)

Taiwan

096116136

5/7/07

Notice of Allowance

22nd Century

Filed 9/13/06

United States

11/520036

9/13/06

22nd Century

Nucleic Acid Sequences

Canada

2688306

5/23/08

NRC**

Encoding Transcription

China

200880100279.3

5/23/08

NRC**

Factors Regulating Alkaloid

Hong Kong

11113618.2

5/23/08

NRC**

Biosynthesis and Their Use

12/601752

5/23/08

NRC**

in Modifying Plant

United States

13/464,212

5/4/12

NRC**

Metabolism

PCT/IB2008/003131 (WO/2009/063312)

Filed on 5-23-2008

*22nd Century holds a non-exclusive license from the Nara Institute of Science and Technology (NAIST) with the right to sublicense.

**22nd Century holds an exclusive worldwide license from the National Research Council of Canada (NRC) with the exclusive right to sublicense.

- 62 -

APPENDIX C

EXAMPLE MINIMUM ROYALTY CREDIT

PERIOD

EVENT

AMOUNT OF LEAF

COMMERCIALISED

BY BAT

RUNNING

ROYALTIES

BASED ON

$100 per

metric tonne

MINIMUM

ROYALTY

CAP

PAYMENT

TO 22nd

CENTURY

BAT CREDIT

(CUMULATIVE)

Pilot Year 1

End of pilot Year 1

$1m

Pilot Year 2

End of pilot Year 2

$2m

First Commercial Period

End of Year 3

$3m

$15m

$3m

First Commercial Period

End of Year 4

25,000 metric tonnes

$2.5m

$3m

$15m

$3m

$3.5m

First Commercial Period

End of Year 5

100,000 metric tonnes

$10m

$3m

$15m

$6.5m

Second Commercial Period

End of Year 6

250,000 metric tonnes

$25m

$5m

$25m

Second Commercial Period

End of Year 7

260,000 metric tonnes

$26m

$5m

$25m

Second Commercial Period

End of Year 8

275,000 metric tonnes

$27.5m

$5m

$25m

Etc.

- 63 -

Schedule 2

MATERIAL TRANSFER AGREEMENT

This Material Transfer Agreement (this “Agreement”), effective as of the ______ day of _____, _____, is made by and between 22nd Century Limited, LLC , having an office at 9530 Main Street, Clarence, New York 14031, United States of America ("22ND CENTURY") and British American Tobacco (Investments) Limited (“BAT”), Reg. No. 00074974, with its registered office at Globe House, 1 Water Street, London WC2R 3LA, United Kingdom ("COMPANY").

Further to that certain Research License and Commercial Option Agreement entered into as of the 1st day of October, 2013, by and between 22ND CENTURY, 22ND CENTURY GROUP, and COMPANY (“Research Agreement”), in accepting the materials provided by 22ND CENTURY pursuant to Section 4.02 of the Research Agreement (the “Material”), COMPANY hereby agrees to the following terms and conditions:

All restrictions and obligations of this Agreement relate to the Material together with any progeny, mutants, or replicated forms thereof, and all cells and tissues containing the Material, including any replicated forms and any derivatives thereof.

The Material is to be used only at COMPANY's facilities, COMPANY AFFILIATE’S facilities, (or other facilities selected by COMPANY or COMPANY AFFILIATE) by COMPANY's primary researcher (the “P.R.”), and by individuals working under the P.R.’s direction. No Material will be transferred to any facility other than a COMPANY’s facility or COMPANY AFFILIATE’s facility except under a written agreement prohibiting further transfer to any party other than Company or a Company Affiliate. The Material will be used solely by COMPANY in accordance with the terms of the Research Agreement.

Other than as permitted in paragraph 2 above, no specimen of the Material will be given or made available to any other individual, person, company, institution, firm or corporation without the expressed prior written consent of 22ND CENTURY. This permission to use the Material shall be restricted to COMPANY's use under or pursuant to the Research Agreement only. The rights and licenses of COMPANY to use the Material are the rights and licenses granted in or pursuant to the Research Agreement and delivery of Material to COMPANY or any COMPANY AFFILIATE shall not be deemed to grant any additional or fewer rights or licenses. The Material may not be used commercially unless prior written permission is obtained from 22ND CENTURY or unless it is used commercially in accordance with the terms of or pursuant to the Research Agreement after exercise of the Option (as defined in the Research Agreement) therein. The foregoing provisions in this paragraph 3 are subject to any requirement by COMPANY, any COMPANY AFFILIATE, or any individual having possession or control of the Material under applicable law or pursuant to any judicial or government requirement, regulation or order to transfer any Material, provided that COMPANY takes reasonable steps to provide 22ND CENTURY reasonable prior notice (if not prohibited under such law, requirement, regulation, or order) to contest such request, requirement, or order.

- 64 -

COMPANY will use the Material in compliance with all laws and regulations applicable to the use, storage and disposition of the Material. The Material is experimental in nature, is not for human use, and is provided by 22ND CENTURY on an "as is" basis WITHOUT WARRANTIES OR REPRESENTATIONS OF ANY SORT, EXPRESSED OR IMPLIED, INCLUDING BUT NOT LIMITED TO WARRANTIES OF MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE, OTHER THAN ANY WARRANTY OR REPRESENTATION IN OR PURSUANT TO THE RESEARCH AGREEMENT.

22ND CENTURY does not warrant that the use of the Material will not infringe any valid patent or other proprietary rights or that the Material is safe and without hazards. COMPANY assumes all risks associated with its use of the Material.

This Agreement shall terminate upon termination of Research Agreement or, following exercise of the Option, termination of the Commercial License Agreement (as defined in the Research Agreement) (the "Termination Date"), or as mutually agreed in advance in writing by the parties. Following the Termination Date, COMPANY will, upon written request of 22ND CENTURY, either return all the remaining quantity of the Material to 22ND CENTURY, or certify in writing to 22ND CENTURY that it has destroyed all the remaining quantity of the Material in COMPANY's possession.

As the parties are located and/or will be doing business in different countries, and seek certainty in their dealings with each other and with other parties, the parties to this Agreement expressly acknowledge and agree that this Agreement, and the performance or breach thereof, shall be entered into, interpreted, governed, construed, and enforced in accordance with the substantive and procedural laws of the State of New York, in the United States of America, without regard to any choice of law principles. Each party agrees to bring any action or proceedings in respect to any controversy or claim arising out of or relating to this Agreement, or the breach thereof, including without limitation any inability of the parties to reach an agreement in the future as to any matter with respect to which such agreement is required or anticipated by this Agreement, exclusively in the United States of America, Supreme Court of New York, Erie County, or in the District Court of the United States of America for the Western District of New York, and the parties further consent to the personal jurisdiction of such courts.

Nothing in this Agreement modifies, amends, alters, changes, terminates, waives, or limits any right, obligation, term, condition, warranty, representation, or provision in or pursuant to the Research Agreement. In the event of a conflict or discrepancy between any provision(s) of the Research Agreement and any provision(s) of this Agreement, the provision(s) of the Research Agreement shall prevail and control.

- 65 -

22nd CENTURY LIMITED, LLC			BRITISH AMERICAN TOBACCO (INVESTMENTS) LIMITED

By:			By:
Name: Joseph Pandolfino			Name: Gary Nicholson (Authorised
Title: Chief Executive Officer			Signatory)
Date:			Title: Head of Global Leaf Research
			Date:

	By:
	Name: Steve Burton (Authorized Signatory)
	Title: Head of CORA and GR&D Finance
	Date:

- 66 -

Schedule 3

NON-DISCLOSURE AND CONFIDENTIALITY

22nd Century LLC (“ 22nd Century ”) and British American Tobacco (Investments) Limited (“ BAT ”) (each, a “ Party ”) entered into a certain Research License and Commercial Option Agreement dated _____ __, 2013 (the “ Agreement ”), pursuant to which 22nd Century and BAT agree to conduct various meetings, whether personally, by telephone, or by other means. The individual identified below in the signature block (“Individual”) wishes to participate in such a meeting. In consideration for being permitted to participate in the meeting on behalf of one of the Parties (the “ Represented Party ”), Individual agrees, upon signing below, to the following terms and agrees to comply with the following terms.

1. Individual acknowledges that, in the course of, or in connection with, the meeting, Individual may learn, receive, obtain, or be disclosed, provided, or provided access to documents, documentation, samples, tests, data, items, inventions, systems, methods, and information or property of any kind, whether in writing, electronically, tangibly, orally, visually, or otherwise (the “ Information ”).

2. Subject to paragraph 4 below, Individual will treat any Information with reasonable care and will not disclose any Information to any other person, firm or corporation, except to the Represented Party or to any person to which the Represented Party is permitted under the Agreement to disclose the Information. If and to the extent that Individual is obligated pursuant to the requirements of applicable law or pursuant to any judicial or government requirement, regulation or order, including without limitation any securities regulations, Individual shall first notify the Represented Party and follow the directions of the Represented Party to the greatest extent as Individual is permitted to do so under applicable law.

3. Individual does not receive any right, title, interest, or license in or to any Information and agrees not to use, utilize, reproduce, copy, create derivative works from or improvements, modifications, or derivations to, or reverse engineer, decompile, or disassemble any Information, except solely for and on behalf of the Represented Party if and to the extent that Represented Party has a right under the Agreement to use, utilize, reproduce, copy, create derivative works from or improvements, modifications, or derivations to, or reverse engineer, decompile, or disassemble such Information.

4. This document applies to and covers all Information, provided, however, that: (i) if any Information belongs to the Represented Party, nothing in this document affects the right of the Represented Party to authorize Individual to disclose, use, and utilize such Information as decided by the Represented Party within its rights to such Information, and (ii) if any Information belongs to the other Party, nothing in this document affects the right of the Represented Party to authorize Individual to disclose, use, and utilize such Information if and to the extent the Represented Party has the right under the Agreement to disclose, use, and utilize such Information.

5. Nothing in this document grants, or shall be deemed to grant, any right, title, interest, or license in or to any Information to the Represented Party, without limiting any right, title, interest, or license granted to the Represented Party under the Agreement.

By signing below, Individual agrees to all of the foregoing provisions:

Signature of Individual:			Date:

Name of Individual (print):

Title of Individual:

Represented Party:

- 67 -

EXHIBIT 21.1

SUBSIDIARIES OF

22 nd Century Group, Inc.

	State of
NAME	formation

22nd Century Limited, LLC	Delaware
Goodrich Tobacco Company, LLC	Delaware
Hercules Pharmaceuticals, LLC	Delaware

EXHIBIT 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We consent to the incorporation by reference in Registration Statement Number 333-173166 on Form S-8 of 22nd Century Group, Inc. of our report, dated January 30, 2014 , on the consolidated financial statements as of and for the years ended December 31, 2013 and 2012, appearing in this Annual Report on Form 10-K of 22nd Century Group, Inc.

/s/ Freed Maxick CPAs, P.C.

Buffalo , NY

January 30, 2014

EXHIBIT 31.1

CERTIFICATIONS

I, Joseph Pandolfino, Chief Executive Officer of 22nd CENTURY GROUP, INC., certify that:

I have reviewed this annual report on Form 10-K of 22nd CENTURY GROUP, INC.;

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting.

The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing equivalent functions):

	Date: January 30, 2014

	/s/ Joseph Pandolfino
	Joseph Pandolfino
	Chief Executive Officer
	(Principal Executive Officer)

EXHIBIT 31.2

CERTIFICATIONS

I, John T. Brodfuehrer, Chief Financial Officer of 22nd CENTURY GROUP, INC., certify that:

I have reviewed this annual report on Form 10-K of 22nd CENTURY GROUP, INC.;

	a.	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

	b.	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

	Date: January 30, 2014

	/s/ John T. Brodfuehrer
	John T. Brodfuehrer
	Chief Financial Officer
	(Principal Financial Officer)

EXHIBIT 32.1

Written Statement of the Chief Executive Officer and Chief Financial Officer

Pursuant to 18 U.S.C. §1350

Solely for the purposes of complying with 18 U.S.C. §1350, I, the undersigned Chief Executive Officer of 22nd CENTURY GROUP, INC. (the “Company”), and I, the undersigned Chief Financial Officer of the Company, hereby certify, to the best of my knowledge, that the annual report on Form 10-K of the Company for the year ended December 31, 2013 (the “Report”) fully complies with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934 and that the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

This certification is being furnished solely to accompany this Report pursuant to 18 U.S.C. 1350, and is not being filed for purposes of Section 18 of the Securities Exchange Act of 1934 and is not to be incorporated by reference into any filing of the registrant, whether made before or after the date hereof, regardless of any general incorporation language in such filing.

	Date: January 30, 2014

	/s/ Joseph Pandolfino
	Joseph Pandolfino
	Chief Executive Officer

	Date: January 30, 2014

	/s/ John T. Brodfuehrer
	John T. Brodfuehrer
	Chief Financial Officer