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22nd Century Group Inc (NYSEMKT:XXII)
Q3 2019 Earnings Call
Nov 8, 2019, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day and welcome to the 22nd Century Third Quarter 2019 Business Update Conference Call. [Operator Instructions].

At this time I would like to turn the conference over to Mr. Tom James. Please begin.

Thomas L. James -- Vice President, General Counsel and 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 forecast indicate or imply future results performance or achievements. The words estimate project intend forecast anticipate plan believe will will likely should may or the negative of such words or words or expressions of similar meanings are intended to identify forward-looking statements.

These forward looking statements are not guarantees of future performance, and also forward looking statements involve risks 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 into December 31 2018. has filed with the Securities and Exchange Commission on March 620 19 22nd century does not undertake and it disclaims any obligation to update any forward looking statements or announce revisions to any of the forward looking statements. During this call. We will also disclose certain non gap financial measures, including adjusted EBITDA. Which we defined as earnings before interest, taxes, depreciation and amortization, as adjusted by 22nd century for certain non cash and non operating expenses. All is described in our company's earnings press release for the quarter ended September 30 2019, has publicly issued yesterday on November 7 2019, and which is available on our company's website.

And I'd now like to turn the call over to Cliff Fleet our company's Chief Executive Officer.

Clifford B. Fleet -- Director and Chief Executive Officer

Thank you Tom. And thanks to everyone for joining today's call. We also thank those who submitted questions for the call in advance of today's discussion and we have incorporated answers to many of those questions in our remarks today. Past three months have been quite busy as we have made meaningful progress against the 2 strategic focus areas outlined three months ago in our previous conference call. We are leveraging the company's leading position and core strengths in plant biotechnology to create shareholder value in the 2 spaces of tobacco and legal hemp/cannabis. Our first objective is to create meaningful change in the tobacco industry by reducing the harm caused by smoking through the commercialization of our proprietary very low nicotine content tobacco and its related intellectual property. Our second objective is to grow our profitable legal hemp/cannabis business in this fast-growing emerging space. We believe the pursuit of these 2 objectives which we are very well positioned to do will create substantial value for shareholders. Over the past few months we have conducted a thorough review of all of our plans and activities to ensure that everything we do supports these 2 objectives and allows us to operate more efficiently than in the past. I'm going to talk about the company's strategies plans and overall performance during the third quarter and year-to-date against these 2 strategic areas of focus.

And then John 22nd Century's Chief Financial Officer will review highlights of the company's operational and financial performance for the same time periods. If there are any questions we ask that you please direct them to our Investor Relations team after the call we will be happy to answer them. Our tobacco harm reduction efforts are going very well. As a reminder we have submitted 2 applications to FDA for our very low nicotine content or VLNC cigarette products. These applications which are a modified risk tobacco product application or MRTP and a premarket tobacco application or PMTA are quickly moving through the FDA's review process. Now that these applications are well into scientific review with the agency our tobacco effort is principally focused on 2 critical areas. The first is to work with FDA on these applications so that we can launch our proprietary product under the proposed brand name of VLN upon MRTP approval. And the second is to help ensure the adoption of FDA's proposed reduced nicotine product standard for all cigarettes sold in the U.S. We believe along with many in the public health community and others that the approval of our applications and the adoption of this standard are critical to reduce the harm caused by smoking. We have had active and very constructive dialogue with FDA on both our applications. The FDA continues to move our PMTA through the review process at what appears to be an accelerated rate.

And while we are unable to disclose the details of our dialogue about our MRTP application we are excited that it's also moving quickly through the review process on what appears to be a much faster time frame than previous MRTP applications. Our regulatory affairs team has already begun preparing for the next milestone in the MRTP review process which will be the presentation of our application to FDA's Tobacco Products Scientific Advisory Committee also known as TPSAC. This TPSAC meeting will provide us the opportunity to present publicly and in detail the benefits to public health that will come from the marketing of our VLN products and FDA's proposed reduced nicotine standard all of which has been many years and tens of millions of dollars in the making. While our interaction with FDA is very encouraging we cannot predict when or if our applications will be approved. We will keep shareholders and others informed as this work progresses. And at this point we remain very optimistic. We were encouraged that FDA recently approved its first MRTP application for a tobacco product which we believe bodes well for our applications. We along with many others believe that for our MRTP-approved VLN product to have the most positive impact on public health it should be introduced into the marketplace along with a reduced nicotine product standard for cigarettes.

We have worked with scientists clinicians regulators and others for many years to build the body of science and evidence to prove conclusively the public health benefits of the FDA's proposed product standard. We believe that the over $125 million in clinical research funded by the FDA other U.S. federal government agencies 22nd Century and others which used our spectrum research cigarettes makes the scientific case conclusively that reducing nicotine levels in combustible tobacco cigarettes to minimally or nonaddictive levels will significantly reduce the harm caused by smoking. The tobacco industry has raised many issues with the agency in comments on the advanced notice of proposed rulemaking and in other forms in opposition to the adoption of the proposed reduced nicotine product standard. Many of the comments argue that the rule cannot be implemented because the proposed standard is impossible to meet for a variety of technical issues. We are thus focusing our tobacco development and commercialization efforts to prove conclusively that the technical issues raised by industry against the adoption of the rule are not valid and thus do not preclude its adoption. To that end we are working with North Carolina State University and other research partners to grow GMO and non-GMO low and very low nicotine content varieties of bright and burley tobaccos in a variety of geographies and at scale.

We are also developing different flavor profiles of our VLN products using industry best practices in blending and flavoring to ensure that all very low nicotine content cigarette products appeal to the broadest population of adult smokers. We are also working on other issues such as creating GMO and non-GMO varieties of oriental tobacco and the creation of good agricultural practices for low and very low nicotine content tobacco varieties to ensure that there are no barriers to the rules adoption. These efforts are going very well and we believe in some make the case that the rule is technically achievable. We believe all of our efforts along with the efforts of public health agencies and others will ultimately bring great benefits to public health by reducing the harm caused by smoking while also creating shareholder value. We remain keenly focused on this objective while also now aggressively working on a second path for the creation of long-term value which is to build a legal hemp/cannabis business with both internal investments and external relationships focused on plant biotechnology and other high-value areas. As we have previously highlighted the legal hemp/cannabis space is growing quickly with tremendous opportunities for companies that approach the space in a thoughtful manner that builds upon their existing strength. We have a strong position that we can leverage which is centered around our leadership in cannabis plant research comprehensive expertise in FDA-regulated spaces a leadership team with deep experience in consumer packaged goods as well as a strong and flexible balance sheet.

We have been rapidly expanding our leading position in cannabis plant genetics. We are leveraging our exclusive worldwide multiyear agreement with Keygene a global leader in molecular breeding and plant research involving high-value traits to develop hemp/cannabis lines 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 developed through this exciting and promising partnership. Using DNA-based bioinformatic tools including AI and machine deep learning marker-assisted breeding proprietary rapid cycle growing techniques and gene editing and other plant transformation technologies we will accelerate the development and commercialization of highly valuable hemp/cannabis plant lines. In the past few months Keygene has already conducted a deep analysis of lines created for us by others significantly expanded our cannabis genomic database begun the sequencing and development of high-quality de novo assemblies of a wide variety of hemp/cannabis plant lines developed novel laboratory analysis techniques and obtained valuable information that is already informing our future plant development efforts. We thus remain very encouraged about our prospects. While we believe these efforts will make 22nd Century a sought-after partner and source for plant material in the legal hemp/cannabis industry we recognize that we have opportunities to do more.

We have been carefully evaluating other ways that we can create shareholder value through partnerships investments or other relationships. As such we have been evaluating a variety of companies and believe that there are great opportunities to partner with others for mutual benefit and make investments and acquisitions to create value for our shareholders. Many companies seek our strengths in plant genetics FDA regulations CPG sales and marketing as well as access to capital. And we can thus be selective and thoughtful in our pursuit of productive partnerships. Although we remain open to many possibilities we believe that the highest shareholder value over time will be created through differentiated positioning in the marketplace based on intellectual property assets that are difficult to imitate such as plant IP brands and product design. To fully maximize value from these assets however one needs access to high-quality supply chain partners in growing processing and manufacturing to operate successfully in a potentially highly regulated environment. Furthermore we are putting very disciplined evaluation criteria around our investment analyses including geography management expertise and capability intellectual property assets as well as financial characteristics such as high gross margins rapid revenue growth and very importantly strong projected internal rates of return for 22nd Century as well as downside protection to protect shareholders' interest.

We thus seek relationships with companies that fit these strategic criteria. In doing so we look to build a leading company in the legal hemp/cannabis space with the synergistic portfolio of operating companies with complementary assets viable business models and winning teams. Given recent dynamics in the space which have depressed company valuations while consumer demand continues to grow quickly we believe there are lots of opportunities that are quite promising. We hope to have good news to report on a variety of fronts in the future. Over the past few months we have looked carefully at all of our work to ensure it helps us maximize our efforts against the above objectives in a highly efficient manner. We have found opportunities to significantly reduce our spending in certain areas that are no longer considered critical which allows us to prudently manage our cash utilization while also thoughtfully funding growth investments. These efforts include employee headcount reductions across the organization a charge for which we expect to take in the quarter that employee separations occur.

These cost reduction efforts have already started to show a positive impact on our corporate performance as our underlying cash utilization rate significantly improved from the second quarter of this year into the third quarter. We expect that our underlying cash utilization excluding any investments in outside companies will also improve as we move into next year while still supporting investments in core areas of focus such as our FDA applications support of a reduced nicotine product standard hemp/cannabis plant R&D and our overall hemp/cannabis growth plans. Let me conclude with a few comments about our business results. Our quarterly and year-to-date results are quite noisy with quite a few events distorting the year-over-year comparison. The important takeaway is that after one removes much of this noise our underlying business performance is similar to last year and we are taking aggressive steps to strengthen its performance as we move into next year. John will go into the financial results in more detail but let me summarize some of the major events that had a significant impact on the third quarter and year-to-date comparisons. The principal driver in the year-over-year comparison was the Aurora purchase of Anandia. We received Aurora stock and additional warrants for Aurora stock last year as a result of this purchase. In 2018 we recognized significant gains as a result of the sale of that stock. However we still hold the Aurora warrant.

In 2019 we recognized significant noncash losses as a result of the decline in the market value of those warrants. A second driver in the year-over-year comparison is a noncash charge we took in the third quarter related to asset impairments. We completed a thorough review of all of our assets in the quarter and wrote down those which were not needed to execute our strategic plans. Finally we continued to show a negative gross margin on product sales this year which was positive last year. We have conducted a comprehensive review of the situation and believe that we will return to a positive gross margin contribution in the first quarter of next year with thoughtful and prudent pricing growth and ongoing cost control efforts. We feel very good about 22nd Century's position and prospects. Our PMTA and MRTP applications are working through the FDA approval process with much constructive dialogue with the agency. We are preparing to be in front of TPSAC presenting our MRTP application as soon as the first part of next year. We are rapidly developing lines of hemp/cannabis plants and IP that we believe will be of commercial value. We have a rich and robust pipeline of partnership opportunities in the legal hemp/cannabis space and hope to be able to announce some good news in the future. And we have thoughtfully reduced our spending across the company while also increasing investments in critical growth areas to position us for future success. Given all of that it is indeed an exciting time for the company as it has so many opportunities. 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 more detailed comments on our operating and financial performance for the third quarter and first nine months of the year.

John T. Brodfuehrer -- Chief Financial Officer and Treasurer

Thank you Cliff. Details about our company's performance can be found in yesterday's earnings press release and quarterly Form 10-Q filed yesterday on November 7 2019. All financial comparisons in my remarks are against the comparable year ago time period unless otherwise noted. Our operational and financial performance remains solid with relatively stable revenues the maintenance of a strong balance sheet and adequate liquidity to fund our research and other investments. Our income performance deteriorated from the prior year periods due to the factors Cliff discussed previously as well as several other items but we expect the comparable numbers for income to improve as we move into next year. We also expect some improvement in cash utilization rate due to the cost reduction program. For the three-month period net sales revenue increased from the comparable prior period due to an increase in contract manufactured cigarette sales. And for the nine-month period net sales decreased from the comparable prior year period primarily from a decrease in revenues from the production of filtered cigars. We have carefully evaluated our pricing strategies and plan for this year and next and plan to thoughtfully and prudently manage pricing and sales initiatives to maximize our revenue potential.

This new plant has already resulted in the company taking a cigarette pricing increase in October of this year.Our Cost of Goods Sold increased in both time periods, principally driven by an increase in FDA fees for filter cigars as well as higher labor and equipment maintenance costs. These cost increases resulted in a slight gross loss on sales during both the three and nine months time periods versus a gross profit in both periods last year. We are working diligently to bring our costs down, which in conjunction with our new revenue and product pricing plan should result in a positive gross profit as we go into next year. We are also prudently managing our other expenses. Research and Development expenses significantly declined both times periods due to one time expenses in 2018 related to the MRT P and P MTA applications. Sales general and administrative expenses increased in both time periods due to certain equity stock grants as well as expenses related to the transition in CEOs. We also took certain impairments this year related to trademarks old inventory and other assets that we determined were no longer strategic to our plans going forward. The biggest year-over-year financial comparison issue relates to our investment in Anandia and its subsequent purchase by Aurora. As previously discussed this transaction resulted in a substantial gain for the company last year and a significant noncash expense this year as the value of the warrants we hold declined in value. Our liquidity position remains strong and we believe that our cash cash equivalents and short-term investments are adequate to meet our needs for many years to come.

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 R&D FDA applications contract growing and various other items our monthly cash expenditures in the third quarter of this year were approximately $975000 which is an improvement from the rate of $1.1 million during the second quarter of 2019. We expect that this monthly cash expenditure figure should improve as our business growth plan grows revenues and as we thoughtfully manage our expenses. In summary we are making thoughtful and necessary investments to strengthen our position in both tobacco harm reduction and hemp/cannabis.

We are carefully managing expenses and our liquidity position remains strong which enables the company to be opportunistic as we seek growth. Thank you.

Thomas L. James -- Vice President, General Counsel and Secretary

We thank everyone for joining our call today. If there are any questions please contact our Investor Relations team. Information on how to contact them can be found in yesterday's press release and on the company's website. We wish everyone a good day.

Operator

[Operator Closing Remarks].

Questions and Answers:

Duration: 22 minutes

Call participants:

Thomas L. James -- Vice President, General Counsel and Secretary

Clifford B. Fleet -- Director and Chief Executive Officer

John T. Brodfuehrer -- Chief Financial Officer and Treasurer

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