22nd Century Group, Inc. (XXII) Earnings Call Transcript

Thank you. Welcome to the 22nd Century Group's second quarter 2026 conference call and webcast. [Operator Instructions] It is now my pleasure to turn the call over to Dan Otto, Chief Financial Officer of 22nd Century Group.

Good morning, everyone, and welcome to 22nd Century Group's second quarter 2026 earnings conference call. Thank you for joining us. With me on the call today is Larry Firestone, Chief Executive Officer. Before we begin, please note that today's remarks include forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those described in these statements. Please refer to the company's earnings release and SEC filings, including our most recent annual report on Form 10-K, for a discussion of these risks and other factors. In addition, during today's call, management may refer to certain non-GAAP financial measures. Reconciliations of those measures to the most directly comparable GAAP measures are included in the company's earnings release. I'll now turn the call over to Larry.

Thanks, Dan, and good morning, everyone. Thank you for joining us today and for your continued interest in 22nd Century Group. The second quarter was an important period for our company. We continued executing a strategy that is reshaping 22nd Century into a stronger, more focused, and ultimately more profitable business. That strategy is centered on building a scalable branded platform led by our proprietary reduced nicotine tobacco products, including our flagship VLN cigarettes, expanding distribution of our higher-margin products, improving our product mix and moving decisively away from the legacy business that did not generate acceptable economics. 22nd Century is the leader in low-nicotine tobacco and low-nicotine combustible cigarettes, designed with authentic tobacco to help smokers reduce their nicotine consumption. We're seeing smokers choose our VLN products as an alternative to full-strength combustible cigarettes. And we believe this category has meaningful room to grow. More broadly, our direction is clear. We are prioritizing profitable growth over uneconomic volume. We are investing behind brands that can win at retail, and we are aligning our commercial model, pricing strategy and manufacturing footprint to support a stronger earnings profile over time. The first half of 2026 reflects a company in transition, but transition with purpose. Historically, too much of our business was tied to high-volume, low or negative margin contract manufacturing. That volume may have added scale, but did not create durable value. In many cases, it created negative working capital, absorbed factory capacity and masked the true earnings power of the branded platform we are now building. Today, we are taking a different path. We are building 22nd Century around higher-quality revenue streams, branded products, differentiated offerings and categories where we can compete on value, innovation and margin rather than simply on price. We believe that shift is the right one for shareholders and the right one for retail partners and the right one for the long-term future of the company. Let me turn now to what we believe were the most important developments in the quarter: Commercial progress, pricing discipline and the foundation for margin improvement in the second half of the year. The second quarter delivered meaningful validation of the opportunity in front of us. We announced new distribution that will be ramped up to begin selling in Q4 for Pinnacle VLN in Metro New York and Northern New Jersey through one of the nation's largest cigarette retailers. This expansion adds nearly 150 high-visibility store locations in a dense and attractive market, creating another strong platform for consumer trial, brand awareness and incremental high-margin revenue. That matters for several reasons. First, it is another proof point that retailers are increasingly willing to allocate space to the Pinnacle platform and the low-nicotine offerings under the Pinnacle brand. Second, it shows that our commercial discussions are translating into placement with meaningful operators in attractive geographies. And third, broader distribution is one of the key levers for accelerating awareness, trial and repeat purchase over time. We also continue to build out the broader Pinnacle branded portfolio, including the launch of Pinnacle Pure. This is strategically important because we do not view Pinnacle as a single product story. We view it as a growing brand family that can compete across multiple product types, price points and merchandising positions. The more complete our portfolio becomes, the more relevant we are to retailers and the more leverage we have in distribution discussions, and we believe our Pinnacle brand is poised to become a national brand. Further, we believe Pinnacle Pure opens up a particularly compelling opportunity. In the premium Tier 2 cigarette category, especially within tobacco and water style product offerings, there are relatively few strong options available from major retailers and traditional cigarette purveyors. That gives us room to differentiate our brand, win new shelf space and support the broader momentum of the Pinnacle franchise. Importantly, the success of the conventional Pinnacle portfolio also supports the adoption of Pinnacle VLN because both the retailer and the company benefit from broader brand recognition and the ability to merchandise the brand across multiple slots in the store. Beyond what we announced during the quarter, we are encouraged by what we are seeing in the pipeline. The progress we made in Q2 is generating follow-on interest from additional large retailers and cash-and-carry operators. We're also seeing growing interest from new classes of trade, including drug and digital-first convenience. In other words, the funnel is broadening, and that's exactly what we want to see at this stage of commercialization. At the same time, we want to be clear about where we are in the revenue cycle. Much of the volume we have seen to date still reflects initial load-in orders. That's an important milestone, but it's only the beginning. The next phase is about execution, converting initial placement into repeat purchasing, increasing velocity at store level and building a recurring revenue base that becomes more predictable and more profitable over time. That is why our focus in the back half of the year is not just on adding slots, but on activating those slots. Our objective is to grow total store count from approximately 2,000 to 5,000 by year-end across roughly 35 states, while also improving rate of sale and consumer pull-through. Those 2 goals must work together. Distribution without sell-through is not enough, and strong unit economics require both broader placement and better recurring movement at retail. To support that next phase, we're refreshing our marketing approach and adding expertise that we believe will strengthen commercial execution in the second half. Our goal is straightforward: Faster adoption, deeper penetration and better conversion of pipeline interest into productive durable accounts. Another major theme of the quarter is pricing discipline. Across the tobacco industry, successful operators manage pricing carefully to recover declines in unit volume, increases in excise taxes and offset inflationary pressure across material, labor and overhead. We are doing the same. We have taken steps to ensure that our pricing better reflects the real economics of manufacturing and distribution, and we believe that this discipline is necessary if we're going to build a sustainable and investable business. This is especially relevant in the legacy CMO business, where significant volume historically came with low or even negative gross margin. As we have implemented pricing changes to improve profitability, some customers have chosen not to continue with 22nd Century and instead moved to lower-cost suppliers. We view that as an acceptable consequence of rational pricing. Let me be very clear. We are not interested in holding on to revenue that undermines gross profit and consumes factory capacity without creating shareholder value. If a piece of business cannot meet appropriate economic thresholds, it is not the right business for us to pursue. Our reported revenue and volume will continue to reflect the final stages of this transition over the next 2 to 3 quarters. Just as important, the business we are building in its place is better business. Our branded platform and particularly products under the Pinnacle brand, offers stronger margin potential, greater brand equity and better strategic positioning than legacy contract volume ever could. So while our low-quality CMO revenue will decline, we believe the mix shift is underway and is directionally very positive for the company. As we look forward, we continue to expect the legacy CMO transition to play out over the balance of 2026 and into early 2027. By the end of 2026 or early first quarter of 2027, we believe the majority of the remaining legacy CMO volume in categories such as filtered cigars, white-label cigarettes and export cigarettes will be substantially transitioned away from our factory, and those contracts will be largely wound down. That does not mean factory utilization stops mattering. It still does. Our contracts and pricing are now much better aligned with the economics we need, but sustained gross margin improvement still requires sufficient profitable volume to absorb the fixed cost structure of the plant. While our pricing reset has been critical, it is only part of the equation. The other part is replacing low-quality volume with better quality, higher-margin revenue streams that can scale. That is why we continue to view the Pinnacle platform, our broader branded portfolio and our expanding commercial reach as the primary drivers of financial improvement going forward. When you put these pieces together, the gross margin story becomes clearer. We believe 3 forces are beginning to work in our favor. First, we are expanding distribution of products that carry better margin potential than the legacy volume they are replacing. Second, we are moving from initial load-in towards repeat sales, which should help improve revenue quality and factory absorption over time. Third, we believe our major contract and pricing actions are now substantially in place, giving a stronger economic foundation from which to operate. For that reason, we believe the second half of the year should begin to show the benefits of the repositioning we have been discussing over the last several quarters. We are not declaring victory, and we know execution remains critical, but we do believe the building blocks for gross margin enhancement are materially stronger than they were at the start of the year. Over the long term, we are building a strategy that is succeeding in the U.S. and that can ultimately extend beyond the U.S. to international markets facing many of the same challenges. We were first to market with our low-nicotine technology, and maintaining that leadership will require continued investment in product development, technology and distribution. Our pipeline of retailer discussions remains very active. As our low-nicotine products continue reaching consumers in the market, we expect to keep building awareness, generating sales data needed to support the broader national and over time, international expansion. We have clear targets for the second half of 2026 that we believe can establish the foundation for a stronger 2027. Shipments of our branded products in the second half of the year are expected to be significantly larger than the first half of 2026. At the same time, we will continue completing the wind down of the volume-driven CMO business and focus our resources on growing branded products. So to summarize, the second quarter reinforced that 22nd Century is moving in the right direction. We expanded commercial distribution. We advanced the Pinnacle brand platform. We broadened our opportunity set across retail and alternative channels. We maintained pricing discipline, and we continue to exit lower-quality business in favor of revenue streams with better economics and stronger long-term strategic value. And with that, I'll turn the call over to Dan to go through the financial results in more detail.

Thank you, Larry. For the second quarter of 2026, net revenue was $2.9 million compared to $4.1 million in the first quarter of 2026, a sequential decline of approximately 29%. For the first half of 2026, net revenue was $7 million compared to $10 million in the first half of 2025. As Larry noted, our first half top line as well as expected over the next two quarters continues to reflect the intentional transformation of the business that we've already been discussing for several quarters, shifting away from the majority of our contract manufacturing business and focusing on our reduced nicotine products and branded offerings, which we believe provides substantially better gross margin potential. Turning to gross margin. Both quarters in the first half of 2026 generated gross losses, but the trajectory is informative. Gross loss for the second quarter was $0.3 million compared to a gross loss of $0.6 million in the first quarter of 2026. On a year-over-year basis, our second quarter gross loss also narrowed meaningfully versus the $0.6 million recorded in the second quarter of 2025, reflecting our deliberate shift away from low-margin CMO export volume and toward higher-margin Pinnacle and VLN SKUs. Included in second quarter gross margin were two discrete items. First, we recorded a one-time charge of approximately $196,000 for the reversal and write-off of aged inventory discontinued by one of our contract manufacturing customers. Second, and offsetting the first, we recognized a one-time MSA NPM excise tax recovery of approximately $692,000 covering prior tax periods. We view both items as non-recurring and neither is reflected in our forward planning. For the first half of 2026, gross loss was $0.9 million compared to $1.2 million in the first half of 2025. While the narrowing of gross loss year-over-year is a positive directional signal, the pace of improvement has not been as fast as we planned. I'll come back to our expectations for the second half of 2026 in a moment. Operating loss for the quarter was $3.3 million compared to $3 million in the first quarter of 2026. Net loss from continuing operations for the quarter was $3.3 million compared to $3 million in the first quarter, and adjusted EBITDA was a negative $3.5 million compared to $2.6 million in the first quarter of 2026. Turning to the balance sheet. We ended the quarter with cash and cash equivalents of $6.1 million and no outstanding debt. We continue to manage liquidity carefully and remain focused on aligning spending with our highest priority commercial and regulatory initiatives. Capital allocation remains disciplined. Resources are being directed toward distribution growth, VLN commercial, Pinnacle portfolio launch, marketing initiatives and advancement of our reduced nicotine pipeline. Looking ahead, our focus for the remainder of 2026 and the central reason we continue to believe in a second half inflection is execution across two priorities: distribution growth and margin improvement. First, distribution. We ended the quarter with a retail presence of approximately 2,000 stores across 20 states, and we're targeting expansion to approximately 5,000 retail outlets by year-end 2026 across 35 states for our VLN and partner VLN cigarette products. That expansion is already underway with recent entries in the Metro New York, Northern New Jersey and California. Looking beyond the convenience channel, we anticipate onboarding additional independents, cash and carry operators and a new digital-first convenience chain to help fill out that 5,000 store footprint, each contributing incremental stocking orders that support gross margin improvement. Second is mix and absorption. We expect continued expansion of our product portfolio, together with higher-margin Pinnacle Pure and Pinnacle VLN reorder activity to improve the gross margin trajectory in the back half. At the same time, we continue to manage the absorption impact of lower overall plant volume as legacy contract manufacturing winds down. That balance, better mix offset with lower legacy volume essential to the second half story. Our 2026 strategic priorities remain unchanged: expand VLN distribution, manage costs with discipline and advance toward meaningful improvements in gross margin. With that, I'll turn the call back to Larry for closing comments.

Thanks, Dan. Many companies in the tobacco and adjacent industries describe themselves as a leader or leading within a particular niche. We believe 22nd Century has earned a differentiated leadership position as we are the leader in low-nicotine tobacco and low-nicotine combustible cigarettes made from authentic tobacco designed to help smokers reduce their nicotine consumption, and we intend to maintain that position. We've spent 28 years developing the technology portfolio that has brought us to this point. Today, our VLN low-nicotine products are in the market. Consumers are buying them, and we have a strategy to expand the category further through additional blends and brands. We will continue to engage with the FDA, pursue the necessary authorizations, maintain our technology leadership, and work to establish a meaningful position in the global tobacco market. With our current authorizations, we believe our first-mover advantage remains significant. We're building a different 22nd Century, one driven by better brands, better distribution, better pricing, and better economics. We believe the commercial traction we're seeing today is laying the groundwork for stronger margins, stronger recurring revenue, and stronger shareholder value over time. Our job now is focused on execution, getting our brands and products into the hands of adult smokers who are looking for a familiar alternative to their full-nicotine cigarette. We are pleased to welcome Katherine Rouse-Bailey as our Vice President of Marketing. Consumer awareness is critical, and navigating brand building within the constraints of tobacco marketing requires the right expertise. We believe Katherine is well equipped to lead that effort. We also expect to add talent selectively in other parts of the organization, including sales and R&D, to support our expanding retail presence and the continued work required across science, product development, and technology. We expect to have additional developments to share in the coming months, and we also plan to present at the H.C. Wainwright Conference in New York in September, along with other conferences in the fourth quarter. Finally, I want to thank our team for their hard work and commitment. The road to this point has not been easy, but we believe the road ahead is exciting and rewarding. The dedication of our employees has been and will continue to be critical to our success. We appreciate your continued interest in 22nd Century and your participation on today's call. Thank you and have a great day.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.