Getting To The Details At 22nd Century Group, Inc.

| About: 22nd Century (XXII)


Reduced or low nicotine cigarettes are potentially an important part of the future of the tobacco industry.

That the FDA now controls the industry (effectively) makes for an uncertain regulatory landscape, but one that will likely favor smoking cessation products.

22nd Century Group is one of the most prominent names in this area and it's trying to do what Vector Group failed to do with its lead technology.

It's doing this with a second generation version, meaning there's a chance it will succeed where Vector failed.

It's a risky allocation, as financing through equity issue is almost an inevitability, but if its Brand A gets a regulatory green light, there's plenty of reward on offer.

The reduced nicotine approach smoking cessation has been the subject of hot debate for the past ten years. If a person smokes cigarettes that have a very low nicotine content, this should theoretically reduce their dependence on nicotine, and in turn, their desire to smoke cigarettes (for the purposes of this discussion, we're going to fall in line with the suggestion that it's the nicotine that's the root of addiction, and not alternative theories).

It sounds like a decent theory, but there are plenty of counterpoints that opponents to the low nicotine content use to rebuke the implications of any such move. Smokers might consume more cigarettes in an attempt to compensate for the reduced per-smoke amount. The same smokers might over-smoke a cigarette, which studies suggest can result in a threefold increase in the amount of tar inhaled per cigarette.

These counterpoints noted, however, there's a lot of evidence that suggests the reduced nicotine hypothesis is well founded.

Here's one from 2012, one from 2013 and one from 2014. These are university and cancer center conducted studies, involving anything from 100 to 1,300 participants, all of which have concluded that reducing the nicotine levels in a cigarette can reduce the number of cigarettes a person smokes across a predefined period of time and/or result in an improved quit rate when used in conjunction with standard of care smoking cessation products, as opposed to the latter on their own.

The most recent study in the field, and the one generally regarded as a pivotal investigation into the matter, was funded by the National Institute on Drug Abuse (NIDA) and the U.S. Food and Drug Administration (FDA) and conducted at the University of Pittsburgh. It was published in the New England Journal of Medicine in October 2015 (link) and compared the impact of a very low nicotine product to a standard (participant's usual) brand in cigarettes smoked and quit attempts.

The study concluded that participants in the active arm (very low nicotine) cigarettes smoked fewer cigarettes per day (14.9) than those in control (22.2). It also concluded that participants in the active arm doubled their quit attempts versus those in control.

Again, it's important to note the limitations of this study. Over-smoking, as described above, is tough to qualify conclusively. As is the potential for inaccurate participant self-reporting.

Whatever the reality of the dispute, the prevailing trend seems to fall in favor of the suggestion that reduced nicotine can be beneficial. The so-called FDA Deeming Rule, which for those not familiar with it essentially handed over control to the FDA over anything that contains nicotine, reinforces this trend. It came into force in August last year, and the industry has been trying to forecast the impact of said rule ever since.

So by now, readers are asking where we're going with this.

Well, Big Tobacco has opposing views on the matter. The above-mentioned Deeming Rule is basically the completion of a rule that first hit press back in 2009, on the back of an Obama bill. Altria Group, Inc. (NYSE:MO) supported it. Pretty much every other big player did not.

This means that there are companies that are willing to embrace the shift, and indeed, some (read: Altria) that are likely looking to get a jump on the competition because they know it's just a matter of time before the FDA mandates nicotine reduction.

So here's the point: If the FDA does mandate said reduction, there's only one company that has the capability to grow tobacco plants that contain nicotine levels at or around the level reported by the WHO as being a threshold for causing addiction. This company is 22nd Century Group, Inc. (NYSEMKT:XXII).

Some reading might already be familiar with the name. It's fallen in and out of favor with markets at various points across the last seven years, and a number of Seeking Alpha authors have expressed various, and often opposing, opinions as to its prospects.

For those new to the company, however, it's a plant biotechnology company that has developed, and patented, a method of producing tobacco that contains the above-mentioned, below addiction threshold, nicotine concentration. Well, to be a little more accurate, it was developed at North Carolina State University on the back of a funding grant from Joseph Pandolfino, 22nd's founder.

It was then sublicensed to Vector Group Ltd. (NYSE:VGR), with the goal of the latter developing a brand (which it did, called Quest) of low nicotine cigarettes and carrying the brand through an FDA approval process so as to allow the company to market Quest as a smoking cessation product.

It didn't work out that way.

Vector conducted a Phase II study (results here) and then said it wasn't going to push for a Phase III. 22nd Century took Vector to court, got back the rights to the grow process and also won the rights to use the Vector-generated data in its own FDA submissions.

During this period, 22nd Century conducted a raft of its own studies (funded by public institutions such as NCSU) and refined its technology.

This is very important.

The technology that 22nd Century relies on now, and that for which it has a suite of patents, is a so-called second generation technology. This affords it certain advantages over the Quest product that Vector tried to market. The company has taken this technology and produced a branded product called Brand A, which is the very low nicotine product on which the majority of its current valuation lies. Right now, it's trying to get the FDA to approve it as a smoking cessation product by way of an application process that we'll look at shortly.

So, the situation is this: 22nd developed the technology with NCSU then licensed it to Vector. Vector branded the Quest product and tried to get it approved as a smoking cessation product. Vector didn't manage to do this, and 22nd Century spent the period in and around Vector's abandoning of the product refining the technology in conjunction with, again, NCSU. It's now taken that refined technology, used it to produce a second generation brand (Brand A) and is trying to do what Vector failed to do, but with a superior product.

The company submitted a Modified Risk Tobacco Product (MRTP) application to the FDA in an attempt to achieve this aim, but received feedback earlier this year detailing the agency's requiring of more data to support the very low nicotine claim. Exactly what the agency wants remains unclear (it's rare we get much insight from either a company or the agency in these sorts of situations) but we know that the resubmission needs to "include additional scientific data and information from already completed clinical studies."

The implications of this working are, then, that 22nd Century isn't going to have to conduct any more trials to support its application. That's an assumption based on wording, but it's a reasonable one. This is important because additional trials would require funding, and the fewer shares the company has to issue between now and any potential regulatory green light, the better.

Regardless, management has decided that on the back of the feedback, it's going to split the MRTP into two parts - a Premarket Tobacco Product (PMT) application and a separate MRTP application. The former is essentially an application that will allow the company to start selling the product (but not label it as a smoking cessation aid), and the time to approval on this is expected to be shorter than that of a combined submission.

The next major catalyst, then, is rooted in this application. There was some concern among Big Tobacco that the FDA taking control of the industry would result in the approval for sale of very few new tobacco products. Indeed, there's some suggestion that the above-mentioned support of the initial Bill by Altria was rooted in this concept - no or few new products would essentially monopolize the market for the existing brands. Whatever, the reality, the result of the PMT application will say a lot about how the FDA views the low nicotine cigarette, and specifically, 22nd Century's Brand A.

If it gets approval for sale, it suggests that the agency deems it as potentially having a positive impact on the tobacco space from a health perspective. This, in turn, suggests that 22nd Century can get its MRTP approved, even if it takes a little longer, assuming it can provide the data the FDA has requested to bolster the submission.

Management initially stated that it expects to submit the revised (and separate) applications at some point this year. In a recent letter to shareholders, CEO Henry Sicignano refined this to a filing of both before the end of the first half of the year. That means we should see submissions this quarter, and serves up the potential for an approval of the PMT (at least) before the end of 2017.

If the PMT is approved, the MRTP could (should) follow during 2018, at which point, 22nd Century will become the only company in the US with an FDA approved very low nicotine smoking cessation cigarette. Combine this with the industry trends outlined in the introduction to this piece, and the evidence that supports the impact said type of cigarette can have on smoking habits, and it paints the company as a potential winner.

How do things stand financially?

The latest report (this 10-K, released March 8, 2017) put cash on hand at a little over $13.46 million at December 31, 2016. Burn comes in at circa $750,000 monthly, and management expects (with these expectations supported by the just mentioned numbers) current cash to last through May 2018.

There's the potential for up to $7 million in milestone payments based on a 2013 licensing arrangement with British American Tobacco plc (BTI), which expires this coming October, but the two companies have been tight lipped on how this is progressing and/or will play out. Since information related to this agreement is thin on the ground, it's sensible to exclude the potential for milestone cash from any cash runway calculations.

Revenues for the full year 2016 hit $12.27 million, up from $8.52 million in 2015, and net loss for the two years in question came in pretty much unchanged at $11.58 million and $11.03 million respectively.

There are a couple of things to note here on these revenue figures. Management, in its latest letter to shareholders, outlined the fact that many of 22nd Century's shareholders would like to see the company reduce (or even terminate) the commercialization efforts it currently undertakes with a few of its legacy tobacco brands. The reduction, these holders argue, would free up resources to focus on the pharmaceutical and regulatory side of things - a side that has the potential to dramatically outweigh the current commercial operations in terms of revenue generation.

Again referencing the shareholder letter, CEO Sicignano suggested that the company was taking these shareholder opinions on board (to a degree), and he made reference to regulatory efforts in the UK as representative of this point. This is important, because chances are we're not going to see any substantial rise in revenues over the coming year or two, while the regulatory side of the operations take center stage.

The company, in taking this approach, is positioning itself more as a development stage biotechnology company, in the sense that it's focusing capital resources on bringing a product to market and running at a loss, in anticipation of loss recovery once it picks up a regulatory green light.

This, of course, increases the risk of dilution. Biotechnology stocks need shareholder cash to get them over the regulatory line, and this shift from commercial to regulatory focus increases the dilution an early position in 22nd Century is going to have to withstand.

So, on that note, what are the risks?

Well, there are a few, but the primary looks to be financing requirement. We touched on the chances of 22nd Century needing cash to fund any further data collection a little earlier, and while this looks unlikely based on the FDA response wording, it's an uncertainty, and therefore a risk factor.

Data collection aside, 22nd Century is almost certainly going to need to raise to fund operational expenses before it can hope to get its MRTP green light, and then again to fund a commercial launch of its Brand A product. All of these issues are going to impact the value of a holding picked up near term. This impact isn't necessarily prohibitive to an exposure, but they need to be considered ahead of taking a position.

Add in the fact that this is a small cap play, reliant on an approval pathway that another company has already failed to traverse (albeit with an inferior product) and there's added uncertainty surrounding the potential for regulatory success, and time to said success. Added time amplifies the primary financing risk.

All said, however, these are considered risks that come as part and parcel of a development stage healthcare or biotechnology company. The upside potential is real if the regulatory and commercial elements of 22nd Century's pathway combine favorably, and at its current valuation, it's not just real, it's very large.

Looking at potential time frames, the current applications with the FDA probably won't come back approved (in their entirety, so we're talking about both the PMT and the MRTP here) before the end of 2018. At this point, the company can start to capitalize on the FDA designation and start to bring in revenues as a cessation product.

Of course, cross-referencing this with the above capital requirement risk probably means we're going to see a raise before May 2018, which will bridge the gap to the application-return catalyst, and then a second raise at some point close to the end of next year to raise capital to fund commercialization efforts.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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