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22nd Century Group Inc (XXII) Q2 2019 Earnings Call Transcript

By Motley Fool Transcribers - Aug 9, 2019 at 7:03PM

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XXII earnings call for the period ending June 30, 2019.

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22nd Century Group Inc  (XXII 1.70%)
Q2 2019 Earnings Call
Aug. 08, 2019, 4:00 p.m. ET


  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Good day, and welcome to the 22nd Century's Second Quarter 2019 Business Update Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Thomas James. Please go ahead, sir.

Thomas James -- Vice President, General Counsel and Corporate Secretary

Thank you very much. My name is Thomas James, the Vice President, General Counsel and Secretary of the Company. We thank everybody for joining the call and I appreciate you bearing with us as we read the required Safe Harbor Text.

The statements made on today's call that are not based on historical information are forward-looking statements made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include but are not limited to statements regarding our Company's business strategy, future plans and objectives and future results of operations or that may predict, forecasts, indicate or imply future results, performance or achievements.

The words project, intend, forecasts, anticipate, plan, expect, believe, will, will likely, should, may or the negative of such words or words or expressions of similar meanings are all intended to identify forward-looking statements. These forward-looking statements are not guarantees of future performance, and all such forward-looking statements involve risk and uncertainties, many of which are beyond our Company's ability to control. Actual results may differ materially from those expressed or implied by such forward-looking statements as a result of various factors including, but not limited to the risk factors disclosed in our Company's most recent annual report on form 10-K for the year ended December 31, 2018, as filed with the Securities and Exchange Commission on March 6, 2019.

22nd Century does not undertake, and it disclaims any obligation to update any forward-looking statements or announced revisions to any of the forward-looking statements. During this conference call, we will also disclose certain non-GAAP financial measures, including adjusted EBITDA, which we define as earnings before interest taxes, depreciation and amortization, as adjusted by 22nd Century for certain non-cash and non-operating expenses all as described in our Company's earnings press release for the quarter ended June 30, 2019, as publicly issued yesterday on August 7th, 2019, and which is available on our Company's website.

And with that, I would like to now turn it over the call to Cliff Fleet, the Company's Chief Executive Officer.

Clifford B. Fleet -- President and Chief Executive Officer

Thank you, Tom, and thanks to everyone for joining today's call. I am pleased to be here to discuss 22nd Century, its performance and what we believe are the Company's bright prospects. I am excited to serve the Company as its newly appointed CEO, and I look forward to working with our shareholders, employees and others to continue building a great business, by driving historic change in the tobacco industry to reduce the harm caused by smoking and by creating a meaningful and profitable business in the emerging legal hemp/cannabis space.

We believe the pursuit of these growth strategies for which we are very well positioned will create substantial value for shareholders. Before we proceed, let me tell you a few -- tell you about a few changes to the format of the call. I will talk about the Company's strategies, plans and overall performance, and then John, our Chief Financial Officer, will review highlights of the Company's operational and financial performance for the second quarter and first half of 2019.

We will no longer be taking questions from individual shareholders during the call. However, our Investor Relations team will be happy to address your questions personally after the call. We thank those shareholders and others who submitted questions to us in advance of the call. And we have addressed many of those questions in our communications today. We expect the call to last about 30 minutes.

With that, let's begin. As the Company recently announced, Henry resigned as President, CEO and Board member of 22nd Century for personal reasons. We are thankful for his leadership and contributions to the Company over the past several years as he made tremendous progress in his mission to help reduce the harm caused by smoking, and we are grateful that his expertise, advice and counsel is retained in a consultative capacity to the Company.

Also as announced earlier this week, I have recently joined the Company as President, CEO and a Member of the Board of Directors. As explained more fully in that announcement, my background is in consumer packaged goods, particularly tobacco and primarily with Altria, the leading tobacco company in the US, where I was the President and CEO of Philip Morris USA until 2017. Since then I have worked as an advisor and consultant to several start-ups, high growth businesses and non-profits, but none proved more interesting than my work with this Company.

Several months ago, I began working with 22nd Century as a Strategic Advisor, because I was intrigued by the work the Company has done in both tobacco and hemp/cannabis. I was impressed by the potential of the organization, and I found it exciting to work with the Company's Board and Executive team to develop and refine the Company's strategies to capitalize on its potential. I was flattered and honored when the Board then asked me to step into a leadership role to drive the Company forward.

The success of any organization is predicated upon the strength of its leadership team. And recently, the Company made another move of great importance with its elevation of Mike Zercher to the role of Chief Operating Officer, which strengthens what was already a solid leadership team. He has had tremendous success over the course of his career in a variety of domestic and international roles. Mike serves as a vital leader in the organization as we implement our reshape strategies and pursue the opportunities before. I am privileged to work with him, the Board and all of our talented employees as we enter the next chapter of growth for the Company.

We believe the Company's prospects are very bright as we leverage solid foundations in two industries, tobacco and hemp/cannabis to create future shareholder value. We are very well positioned in tobacco as the FDA continues moving toward the adoption of a reduced nicotine product standard that will require all combustible cigarettes sold in the US to contain only minimally or non-addictive levels of nicotine.

Moreover, there is a recently published survey from the CDC Found[Phonetic], 80% of cigarette smokers and 84% of former smokers are in favor of reducing nicotine levels in cigarettes. Clearly, many smokers believe, as we do, along with many in the public health community, that the adoption of this standard is critical to reduce the harm caused by smoking. And so we continued to work to support the efforts of FDA and others to implement this historic change. We have worked with scientists, clinicians, regulators and others for many years to build the now substantial body of science and evidence to prove conclusively the public health benefits of this proposed standard.

We estimate that over the past seven years FDA and other US federal government agencies have invested more than $125 million in research using our SPECTRUM research cigarettes. We believe this research conclusively makes the case that minimally or non-addictive levels of nicotine in cigarettes will significantly reduce the harm caused by smoking both in our own products and when required for all combustible cigarettes.

Our tobacco harm reduction efforts also include the recently filed and very important Pre-Market Tobacco product and Modified Risk Tobacco product applications for the Company's proprietary very low nicotine content cigarettes. With these applications, we are seeking FDAs authorization to commercialize our VLN branded cigarettes, which contain 95% less nicotine as compared to the 100 leading brands of cigarettes in the US. These applications have been accepted by FDA and are now working their way through FDA scientific review. Earlier this year, as part of that review, FDA inspected our manufacturing facility, where VLN cigarettes will be made.

In addition, we continue to have ongoing constructive dialogue with FDA regarding these applications. We are only the fifth company to have a Modified Risk Tobacco product application accepted for filing by FDA. And today, FDA has yet to approve any of those applications. However, we believe approvals of both our PMT and MRTP applications are likely, because the products in these applications are identical to the very low nicotine content research cigarettes used in the FDA sponsored research that I previously highlighted, which underpins the FDAs proposed reduced nicotine standard. Also we believe, along with many others, that these products are of critical importance to FDAs regulatory path for nicotine and for the adoption of a reduced nicotine product standard. So we remain optimistic about their ultimate approval.

The adoption of the reduced nicotine product standard and the approval of our VLN branded products are central to achieving 22nd's -- 22nd Century's mission to reduce the harm caused by smoking and to create shareholder value. So we will continue making appropriate investments in these efforts.

We continued to develop additional varieties of very low nicotine tobacco, including non-GMO varieties, and we have enhanced our regulatory affairs and scientific capabilities with the addition of John Pritchard, as Vice President of Regulatory Science, who was formerly the Head of Regulatory Science for Imperial Brands, UK.

We are actively engaging with various stakeholders around the world to build awareness of our proprietary very low nicotine content cigarettes, our plans to bring these to market and FDAs plans to require all cigarettes sold in the US to be made minimally or non-addictive. We believe these efforts will bring about significant benefits to public health and will also create shareholder value. Thus we will continue to pursue these efforts with vigor and energy that we have -- as we have over the past few years.

So what is exciting about our future is that tobacco is just one of the ways we will create value. We believe that by building on our strong base in hemp/cannabis, we have another exciting and potentially even more valuable path for growth. The legal hemp/cannabis space in the US is centered around products derived from the hemp/cannabis plant, which is legally defined as cannabis containing less than 0.3% THC. We believe the value of the legal hemp/cannabis products market currently totals $1 billion to $2 billion per year.

But not a large market today with the 2018 farm bill legalizing all parts of the hemp plant and with the rapid growth of CBD products, the hemp/cannabis market is believed to be growing faster than even the marijuana industry. Because of this the value of the hemp/cannabis market could surpass the combined value of the medical and adult youth marijuana markets in just a few years. And because this is a very new fragmented market, there are no well-established companies and brands. Rapidly growing spaces with these characteristics present tremendous opportunities for companies, who approach such opportunities in a thoughtful manner that builds upon their existing strengths. And we have many strengths that are a value to this emerging space that we plan to leverage to create shareholder value.

22nd Century has what we believe to be a strong position centered on the genetic pathway for cannabinoid production in hemp/cannabis plants that we can leverage for growth. We also bring other strategic assets to this fast growing category, such as world-class regulatory affairs capabilities, including with FDA and deep expertise in consumer packaged goods branding, marketing and sales. We are seeking the right relationships with emerging organizations in the hemp/cannabis market to leverage these strengths and create long-term value for our shareholders.

Our work in this space began several years ago with our investment in Anandia, which was purchased by Aurora last year. After this purchase, we retained all rights to the research and intellectual property developed in collaboration with Anandia. This includes an exclusive sub-license to the intellectual property that allows us to regulate the genes in the hemp/cannabis plant, as well as the rights to zero THC hemp plants and other valuable cannabis strains. We are in the process of making a series of important, thoughtful and comprehensive investments that add to this strong base and strengthen our leadership position around hemp cannabis plant genetics. We have obtained a license from the State of New York to research and grow hemp in the state.

We have enhanced our internal research efforts with a new research lab and additional personnel. We are building a research growing facility, including a greenhouse in Oregon to support our work in hemp/cannabis. And earlier this year we signed an exclusive worldwide multi-year agreement with KeyGene NV. KeyGene is a global leader in plant research, involving high value genetic and agronomic traits. We have partnered with KeyGene to develop hemp/cannabis plants with valuable cannabinoid profiles and other superior agronomic traits.

We will hold exclusive worldwide rights to all hemp/cannabis plant lines, intellectual property and research results that are developed through this exciting and promising relationship. We believe these efforts to create new plants and IP, in conjunction with other steps that we will take in the future to strengthen our current leadership position in hemp/cannabis plant genetics will make 22nd Century a sought after partner and source for unique plants and high value cannabinoid extracts in these plants.

But we aspire to do more, so we are carefully looking at a variety of other ways to become a major player in this emerging space. We plan to opportunistically create shareholder value through partnerships, investments and other strategic relationships across the entire hemp cannabis value chain, including branded consumer products. We are thoughtfully surveying the landscape and evaluating companies, assets and organizations with the goal of building a platform to drive our growth in this fast growing and exciting category.

In summary, we feel very good about 22nd Century's position and prospects. We are actively working with FDA and others to implement a new agency rule requiring that all cigarettes sold in the US contain only minimally or non-addictive levels of nicotine. We have successfully filed PMT and MRTP applications, which are under review by FDA. We are expanding our strong position built around our hemp cannabis intellectual property portfolio. We are evaluating opportunities to increase our presence in hemp/cannabis genetics, and we are seeking ways to grow into other areas of the fast growing hemp/cannabis value chain. Given the many opportunities before us, it is indeed an exciting time for the Company. I look forward to working with our very talented team, our business partners, our shareholders and others to seize these opportunities and grow our business.

I would now like to turn the call over to John, for comments on our operating and financial performance for the second quarter and first half of the year.

John T. Brodfuehrer -- Chief Financial Officer and Treasurer

Thank you, Cliff. I am going to offer perspectives and highlights on our second quarter and first half performance for 2019. Details about our Company's performance can be found in our earnings release and quarterly Form 10-Q, both issued yesterday. All financial comparisons in my remarks are against the comparable year-ago time period unless otherwise noted.

Our financial position remains solid with the maintenance of a strong balance sheet, adequate liquidity to fund operations, meet obligations as they become due, to fund our research and development and make other potential investments. Our income performance deteriorated from the prior year periods due to factors I will address in a moment. And our underlying cash utilization rate also increased for the first half of 2019 versus the year-ago comparable time period. But cash utilization improved slightly for [Indecipherable] of 2019 versus the year-ago comparable time period. We expect the comparable numbers for income and cash burn to remain relatively constant as the year progresses, although we remain optimistic for potential improvement as a result of possible investments to strengthen our business platform for the long term, which may impact our Company's use of cash and its liquidity position.

For both the three and six month periods, net sales revenue decreased from the comparable prior-year periods. For the second quarter, net sales revenue decreased by 15.9% to $5.8 million, while on the first half of the year net sales revenue decreased by 7.1% to $12.1 million. This decrease in both periods was principally driven by a decrease in production volume in our contract manufacturing business, in line with industry trends. Our cost of goods sold increased in both time periods as a percentage of net sales revenue, principally driven by an increase in fees due to the FDA for filtered cigars as well as higher labor and equipment maintenance cost. These cost increases resulted in a slight gross loss on sales during both the second quarter and the first half versus a slight gross profit in both periods last year. As context, we maintain our manufacturing operations to produce our SPECTRUM research cigarettes and in anticipation of the FDA's approval of our proprietary VLN branded MRTP cigarettes. In the interim, our contract manufacturing business continues to absorb much of our excess manufacturing capacity and overhead.

While tobacco product contract manufacturing is a price competitive business, we are working diligently to bring our manufacturing cost down to return to a gross profit position and sales. We are also prudently managing our operating expenses. For example, research and development expense for the Company decreased in both time periods, as the expenses related to tobacco broadly declined, while expenses related to hemp/cannabis increased reflecting the shifting strategic priorities of the Company.

Last year the Company incurred significant expenses related to its PMT and MRTP applications, while this year we have increased spending to support work in hemp/cannabis with additional investments in laboratory operations and sponsored research. General and administrative expenses were up in both time periods given a variety of factors. We are going to keep a careful eye on these to ensure we are thoughtful and disciplined.

As a result, and due to items I already discussed, as well as other items more fully explained in our earnings press release and in our second quarter Form 10-Q filing, 22nd Century had net losses in both time periods this year that were greater than net losses experienced for the comparable year ago time periods.

For the second quarter, the primary reason for the net loss was a non-cash expense of $1.9 million relating to the Crede lawsuit settlement in an unrealized loss on our investment in Aurora Cannabis stock warrants of $1.4 million. Although the fair value of these stock warrants was positive at over $4.6 million at quarter end. For the first half of 2018, we recorded a significant unrealized gain on our investment related to Anandia. The decrease in this unrealized gain coupled with the Crede settlement expense were the main reasons for the increased net loss during the first half of 2019.

Our liquidity position remains strong and we believe our cash, cash equivalents and short term investments are adequate to meet our needs for a number of years. However, we must successfully execute our business plan to achieve positive cash flows, which we are working hard to do. Excluding discretionary expenses, such as future acquisitions or equity investments, research and development, FDA applications, contract growing and various other items, our monthly cash expenditures are approximately $1.1 million. We expect that this monthly cash expenditure figure should improve over time as our business growth plan delivers higher revenues and as we thoughtfully manage our expenses.

In summary, our financial position remains strong and we are making thoughtful and necessary investments to strengthen our position in tobacco and hemp/cannabis. Our strong liquidity position will enable the Company to be opportunistic as we seek future growth opportunities. Thank you.

Thomas James -- Vice President, General Counsel and Corporate Secretary

We thank everyone for joining our call today. Listeners with questions may contact our Investor Relations department through our website. We wish everyone a very good evening.


[Operator Closing Remarks]

Duration: 22 minutes

Call participants:

Thomas James -- Vice President, General Counsel and Corporate Secretary

Clifford B. Fleet -- President and Chief Executive Officer

John T. Brodfuehrer -- Chief Financial Officer and Treasurer

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This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.

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