22Nd Century Group, Inc. quarterly report, Q3 FY2011

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22nd Century Group, Inc. — Form 10-Q Summary

Reporting period: Quarter and nine months ended September 30, 2011; filed November 14, 2011. Amounts are U.S. dollars. The January 2011 reverse merger means comparative results reflect 22nd Century Limited’s historical operations, with 22nd Century Group’s operations included from the merger date.

Business context

The company is a plant-biotechnology business developing X-22, a prescription smoking-cessation product, and potential modified-risk tobacco products. It also sells RED SUN and MAGIC cigarettes and supplies SPECTRUM research cigarettes under a government-related contract. Management cited 99 issued patents in 79 countries.

Financial results and position

MetricQ3 2011Q3 2010Nine months 2011Nine months 2010
Product revenue$529,370$20,302$801,636$22,102
Therapeutic grant income$80,000—$223,540—
Operating loss$(765,944)$(232,242)$(2,489,742)$(772,482)
Net loss attributable to common shareholders$(465,082)$(300,884)$(2,218,362)$(990,997)
Basic and diluted loss per share$(0.02)$(0.02)$(0.08)$(0.09)
  • Revenue growth was largely tied to SPECTRUM: the company delivered about 9 million research cigarettes in Q3 and recognized $510,935 of revenue. Cost of goods sold was 25% of product revenue in Q3 and 28% for the nine-month period.
  • Research and development expense was $712,000 in Q3 and $1.51 million for nine months, mainly reflecting Phase II-B clinical-trial spending. Nine-month general and administrative expense was $1.38 million; sales and marketing expense was $268,000.
  • Cash used in operations was $2.47 million for the first nine months, versus $651,000 in 2010. Investing activities used $580,000; financing activities provided $3.06 million. Ending cash was just $4,375.
  • At September 30, total assets were $2.44 million, total liabilities $5.62 million, and shareholders’ deficit $3.18 million. Current assets of $1.02 million compared with current liabilities of $2.67 million, or approximately $1.65 million of negative working capital.
  • Reported debt included a $174,925 demand bank loan, $150,000 of short-term shareholder borrowing, and $751,556 of long-term debt before its current portion. A separate $2.72 million warrant liability was recorded.

Material changes versus comparable periods

  • Nine-month product revenue rose from $22,102 to $801,636, principally as the SPECTRUM program moved into cigarette shipments. Revenue growth did not offset higher operating costs: the nine-month net loss attributable to common shareholders more than doubled.
  • Operating cash use increased substantially, while cash remained minimal at period-end. Negative working capital improved from about $4.1 million at year-end 2010 to about $1.6 million, mainly following the January 2011 private placement and liability reductions.
  • The January 2011 private placement generated approximately $3.3 million in net cash proceeds and converted about $614,000 of shareholder debt and accrued interest into equity. Common shares outstanding increased to 27,209,646 at September 30, 2011, from 16 million at December 31, 2010.

Outlook, risks and unusual items

  • Management planned to seek approximately $2.5 million of bridge financing in Q4 2011 and approximately $10–12 million of equity financing in Q1 2012. Completion and terms were uncertain, and the planned equity financing would dilute existing shareholders. Management stated it could not assure that its plans would fund operations through 2012.
  • The company reported that it needed additional capital to fund operations, reduce liabilities, meet upcoming maturities, and continue FDA-related work. It had no outstanding RED SUN or MAGIC order backlog and expected about $25,000 of research-cigarette sales in Q4.
  • The FDA declined the company’s Fast Track request for X-22 in August 2011. Management planned to submit another request using Phase II-B results, expected in December 2011. It expected X-22 approval no earlier than Q1 2013; without Fast Track, management estimated approval could be around Q3 2013. Modified-risk product applications were anticipated in 2012, subject to FDA regulations and authorization.
  • Approximately $822,000 was described in the notes as owed to North Carolina State University (NCSU) for patent costs and license fees, past due; MD&A separately itemized approximately $747,000 of patent costs and $75,000 of royalties. NCSU could potentially terminate the exclusive license after notice and an opportunity to cure if the parties failed to agree on payment arrangements. The related licensed patents had a reported carrying value of about $710,000.
  • The company had not complied with the demand loan’s annual 30-day principal repayment (“clean-up”) requirement, although the bank had not demanded payment. A $150,000 shareholder note was due November 30, 2011. The filing also recorded a $337,500 noncash gain from remeasurement of warrants classified as a derivative liability; the liability was valued using Level 3 estimates.

Important facts for investors to verify

  • Whether the planned bridge and equity financings were completed, on what terms, and with what dilution.
  • Current cash, operating cash burn, near-term debt maturities, and the company’s ability to fund operations through 2012.
  • Phase II-B results, any renewed Fast Track decision, and the actual FDA timelines and requirements for X-22 and modified-risk products.
  • The status of past-due NCSU obligations and any agreement protecting the company’s exclusive license.
  • Whether SPECTRUM deliveries and RED SUN/MAGIC sales can produce recurring revenue; the filing reported no backlog for RED SUN and MAGIC.
  • The assumptions underlying the $2.72 million warrant liability and its potential effect on future reported earnings.