22nd Century Group, Inc. — FY 2011 Form 10-K
Reporting period: Fiscal year ended December 31, 2011; the filing is an annual report, not a standalone Q4 report. The January 25, 2011 reverse merger means the comparative financial statements principally reflect 22nd Century Limited, LLC’s historical operations, with the parent’s operations included from the merger date.
Business context
The company develops tobacco biotechnology intended to alter nicotine levels and other tobacco characteristics. Its activities include SPECTRUM research cigarettes, RED SUN and MAGIC commercial cigarettes, and development of X-22 smoking cessation cigarettes and potential modified-risk cigarettes. It reported 101 issued patents in 78 countries and approximately 38 pending applications.
Financial performance and liquidity
| Metric | FY 2011 | FY 2010 |
|---|---|---|
| Revenue | $788,601 | $49,784 |
| Other income, including therapeutic grant | $223,540 | — |
| Costs of goods sold | $418,171 | $27,964 |
| Operating loss | $(3,755,539) | $(1,097,243) |
| Net loss | $(1,347,787) | $(1,423,647) |
| Cash used in operating activities | $(3,449,430) | $(909,939) |
| Cash used in investing activities | $(607,297) | $(108,116) |
| Cash provided by financing activities | $4,308,666 | $1,018,207 |
- Gross profit was approximately $370,000, or about 47% of revenue, before operating expenses. FY 2011 revenue largely came from the government research-cigarette program; the company delivered approximately 8.8 million SPECTRUM cigarettes. There was no year-end order backlog.
- The reported net loss included a $2.51 million noncash gain from the decline in fair value of warrant liabilities. Operating loss widened substantially; the smaller net loss versus 2010 was not evidence of improved operating profitability.
- At year-end, cash was $252,249; current assets were $971,252 and current liabilities $2,873,783, for negative working capital of approximately $1.9 million. Shareholders’ deficit was $1,212,160.
- Debt and obligations included $1.93 million face value of convertible notes due December 2012, carried at $641,886 net of discounts; a $350,000 vendor note due July 2012; $174,925 of demand bank borrowing; and $753,000 owed to North Carolina State University (NCSU) for patent costs and license fees. The bank loan’s annual clean-up requirement had not been met.
Changes, outlook, and material risks
- Revenue rose from $49,784 to $788,601, mainly due to SPECTRUM deliveries. R&D expense increased to $2.10 million from $364,000, largely for X-22 development and its Phase II-B trial; G&A rose to $1.79 million from $591,000. The company began marketing RED SUN and MAGIC in 2011.
- After year-end, the company reported that its X-22 Phase II-B trial did not show a statistically significant quitting difference versus the active control. It suspended further company-sponsored trials pending results from independent trials, one expected in Q2 2012. FDA approval and modified-risk authorization remained uncertain; FDA had declined X-22 Fast Track designation in August 2011.
- Management said cash was insufficient for 2012 operations and obligations and that additional equity financing and significant licensing arrangements were needed. The company warned that financing might not be available and equity issuance would dilute shareholders. The auditor’s report expressed substantial doubt about the company’s ability to continue as a going concern.
- NCSU agreed not to invoke termination rights for nonpayment or nonperformance until October 15, 2012; after that, termination could follow written notice and an opportunity to cure. The licensed intellectual property is central to the business.
- Management identified no specific numerical revenue or earnings guidance. It expected further losses and negative operating cash flow and had no outstanding product backlog. RED SUN and MAGIC lacked distribution arrangements and orders at year-end.
- Disclosure controls and internal control over financial reporting were judged ineffective due to a material weakness in segregation of duties. Management performed additional post-closing procedures; the auditor did not attest to internal control effectiveness.
- Other significant risks include regulatory approval and market acceptance, dependence on contract manufacturers and partners, tobacco-industry regulation and litigation, unhedged financing needs, product liability exposure, and potential dilution. The filing reported no material legal proceedings pending against the company.
Key facts for investors to verify
- Whether the company obtained sufficient financing to meet obligations and fund operations after year-end, including the convertible-note maturity and other 2012 payments.
- Subsequent X-22 clinical-trial results, any decision to resume trials, and the status and cost of FDA development and authorization plans.
- Whether SPECTRUM orders continued and whether RED SUN and MAGIC secured distribution and generated sales.
- The status of overdue NCSU amounts, the license agreement, and any cure or extension arrangements.
- Potential dilution from convertible notes, warrants, equity financing, and the scheduled July 2012 expiration of major share lock-ups.
- Whether the segregation-of-duties weakness was remediated and disclosure controls improved.