22Nd Century Group, Inc. quarterly report, Q3 FY2012

Full document

22nd Century Group, Inc. — Q3 2012 Form 10-Q

Reporting period: Three and nine months ended September 30, 2012; filed November 13, 2012. The company is a plant-biotechnology business developing tobacco products and technology, including smoking-cessation and potential modified-risk products, and supplying SPECTRUM research cigarettes. Financial statements are unaudited.

Financial performance and position

  • Revenue: Q3 revenue was $15,683, versus $529,370 in Q3 2011. Nine-month revenue was $15,683, versus $801,636. The 2011 comparisons included initial SPECTRUM deliveries; 2012 revenue reflected a modest July order. The 2011 periods also included therapeutic-grant income of $80,000 in Q3 and $223,540 for nine months; the grant was fully recognized in 2011.
  • Costs and margins: Q3 cost of goods sold was $60,852, exceeding revenue; management said cigarettes were provided to RTI without charge. Nine-month cost of goods sold was also $60,852. The filing does not provide a meaningful positive gross margin for 2012.
  • Operating results: Q3 operating loss was $632,548 and net loss was $448,925, or $0.01 per share. Nine-month operating loss was $2,454,066 and net loss attributable to common shareholders was $2,429,915, or $0.08 per share.
  • Cash flow: Operating activities used $1,303,248 in the first nine months, compared with $2,473,746 in 2011. Financing activities provided $1,056,942; investing activities used no cash. Cash fell from $252,249 at year-end 2011 to $5,941 at September 30, 2012.
  • Liquidity and debt: Current assets were $1,210,442 and current liabilities $4,265,454, a working-capital deficit of approximately $3.1 million. Total liabilities were $4,997,107. These included $174,925 of demand bank loans, $623,000 of notes payable, convertible notes with a $2,028,100 face value ($1,628,774 carrying value), and a $653,933 warrant liability. Shareholders’ deficit was $2,358,654.
  • Other metrics: Inventory increased to $1,154,190 from $678,123 at December 31, 2011. Common shares outstanding were 31,048,979 at quarter-end; 31,598,979 were reported outstanding at October 31.

Material changes versus the prior comparable periods

  • Revenue fell sharply as the prior-year periods included initial SPECTRUM contract deliveries and grant income. The company reported only $15,683 of revenue in the first nine months of 2012.
  • Research and development expense declined 68% for the first nine months, to $484,316, primarily after suspending FDA-related X-22 activities. General and administrative expense rose 25% to $1,732,162, mainly due to higher equity-based compensation; sales and marketing expense fell 83% to $46,045.
  • Nine-month net loss increased to $2,431,371 from $2,205,358. Lower revenue and higher interest expense, including debt-discount amortization, more than offset lower operating expenses and a warrant-liability gain.
  • Interest expense and debt-discount/debt-issuance-cost amortization rose to $1,144,721 for nine months, versus $53,116 in 2011. Noncash debt-discount amortization and warrant remeasurement materially affected reported earnings.
  • The May 2012 private placement raised $786,500 in cash and issued 1,710,833 shares and warrants; an August convertible-note financing generated $210,000 in cash. The May warrants’ initial fair value exceeded total offering consideration, resulting in an $814,500 charge.

Outlook, risks and unusual items

  • Management said cash on hand was insufficient to sustain operations or meet obligations as due. Continued operations depended on additional financing and significant licensing arrangements; neither was assured. The board authorized management to seek equity financing, which would dilute existing shareholders.
  • X-22 clinical trials were suspended after the company’s Phase II-B trial did not show a statistically significant quitting difference versus the active control. Management said it would review results from two independent trials before deciding whether to resume company-sponsored trials.
  • Management expected to file applications with the FDA in 2013 for two potential modified-risk cigarette products. FDA authorization, regulatory approval, manufacturing, distribution and market acceptance remained uncertain. RED SUN and MAGIC U.S. orders were on hold pending benchmarks and a potential manufacturing arrangement; no definitive arrangement had been reached.
  • The company owed North Carolina State University approximately $865,000 for past-due patent costs and license fees. NCSU may have termination rights under the exclusive license, subject to notice and an opportunity to cure; approximately $700,000 of related patent assets could be affected.
  • Other obligations were past due or in default: the company had not met the bank loan’s annual clean-up requirement; it had missed a required payment on a $77,000 vendor note, which was callable; and principal and interest on a $350,000 note due July 1, 2012 remained unpaid. Two secured notes totaling $50,000 and a $6,000 officer note due October 1 were also reported unpaid.
  • After quarter-end, the company raised approximately $750,000 in a private placement at $0.25 per unit. The offering included warrants and triggered further anti-dilution adjustments to certain existing securities.
  • Disclosure controls and procedures were reported ineffective; material weaknesses in internal control over financial reporting from the 2011 Form 10-K remained. No material legal proceedings were reported.

Important facts for investors to verify

  • Whether the company obtained sufficient financing and licensing revenue to fund operations, and its current cash runway and obligations.
  • The status of the NCSU license, past-due balances, termination notice or cure rights, and any effect on the related patent assets.
  • The current status of defaulted or past-due bank, vendor and other notes, including any demands, amendments or repayment agreements.
  • Whether the post-quarter $750,000 placement closed as described and the resulting share count, dilution and anti-dilution adjustments.
  • Progress on FDA plans, independent X-22 trial results, SPECTRUM orders, and manufacturing and distribution arrangements for RED SUN and MAGIC.
  • Remediation of the disclosed material weaknesses and any subsequent changes in disclosure controls and internal controls.