22nd Century Group Inc (XXII)

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I can't get the document or the link to copy. Here's the text - not especially helpful as the chart formatting is completely off (I;ve therefore deleted it), but the first page (which describes Bonnie's conversation with Henry and Wells Fargo's take on XXII) and the second page (re Wells Fargo's take on the FDA process going forward) are probably the most interesting.

October 1, 2017 | Equity Research

Tobacco Talk: XXII Mgmt Mtg Takeaways

FDA Disrupts the Old Order, Making Way For the Small & Nimble

? XXII Management Meeting Sheds Light on The FDA’s New Approach towards Nicotine & the Potential Implications for the Tobacco Industry –

We recently hosted an investor meeting with Henry Sicignano III, CEO of 22nd Century Group, Inc. (XXII). XXII is a plant biotechnology company whose proprietary genetic engineering and plant breeding technology enables it to tailor levels of nicotine (and other nicotinic alkaloids) in the tobacco plant as well as tailor cannabinoid profiles in the cannabis plant. XXII owns, or exclusively licenses, more than 200 patents and has more than 50 patents pending. The meeting was an excellent opportunity to hear from a small, but important player in the business of tobacco-related nicotine - the subject at the core of the FDA’s new directive to lower nicotine in combustible cigs to minimally or non-addictive levels. Key takeaways: (1) The FDA won’t rush the process: While we think there is a sense of urgency at the FDA, we still believe it will take 3-5yrs before any potential changes are implemented given the sheer complexities & risks involved (see pg 2); (2) critical decision is how quickly to reduce nicotine: we expect the scientific community to rally around an immediate vs gradual reduction in nicotine levels in cigs – a potential headline risk for big tobacco. It’s our understanding there’s an additional study that could be released by the end of the year which could find an immediate and sharp reduction of nicotine in cigs is ideal; (3) “sweet spot” could be an 85% reduction: recent science suggests reducing nicotine levels in cigs by 85% is optimal (see pgs 2- 4); and (4) The FDA’s vision creates supply challenges: the cost of stripping nicotine out of tobacco presents cost & quality challenges for cig mfrs, but this should be largely manageable for co’s with strong cash flows & reduced-risk product (RRP) portfolios (e.g., MO). Bottom line - Uncertainty remains as to what the FDA may ultimately propose and how the industry may adapt. However, we continue to believe in an environment where nicotine levels in cigs are reduced, conversion to RRPs will accelerate and MO is strongly positioned with iQOS.

? XXII Century Is Positioning Itself to Compete in New, Low Nicotine Environment – XXII has historically focused on the very small, smoking cessation market, but now finds itself in the unique position to have its core, Very Low Nicotine (VLN) product aligned with where the FDA envisions taking the combustible cig industry. In this new environment, XXII’s competitive advantage is its patented technology to genetically modify tobacco plants and, to the best of our knowledge, no other company possesses the same capability or scale in genetically modified VLN tobacco.
? XXII Century Sheds BAT Intellectual Property (IP) Agreement, Targets New Strategic Partnerships – We expect there will be increasing interest from combustible cig manufacturers seeking ways to meet new nicotine standards to be potentially mandated by the FDA. XXII’s unique ability to grow tobacco at very low nicotine levels (0.4mg/g, which is a 95% reduction) should be attractive to companies seeking new lines of supply that are void of the flavor/color/smell challenges that come with chemically stripping nicotine from tobacco.

Please see page 5 for rating definitions, important disclosures and required analyst certifications. All estimates/forecasts are as of 10/01/17 unless otherwise stated. 10/01/17 20:32:36 ET
Wells Fargo Securities, LLC does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of the report and investors should consider this report as only a single factor in making their investment decision.
Tobacco
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Bonnie Herzog
Senior Analyst|212-214-5051 [e-mail] Patty Kanada, CFA Associate Analyst|212-214-5029 [e-mail] Adam Scott Associate Analyst|212-214-8064 [e-mail]
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Tobacco Equity Research

Long, Multi-Year Road Still Ahead –

With the FDA’s announcement occurring just ~2 months ago (7/28), there are still many steps ahead before a potential comprehensive and enforceable nicotine standard can be put into effect (no less than 2 years, by law). The next step is for the FDA to issue an Advance Notice of Proposed Rulemaking (ANPRM), through which it will solicit comments/input from major stakeholders to help inform the rulemaking process. The comment period is typically 30-60 days, but for more complex rulemakings such as this one, it could be 180 days or more. During this period, the FDA will respond to comments and request more information to help form the basis of a viable, scientifically-grounded regulatory plan. Once the FDA is satisfied with the evidence, it will issue a Notice of Proposed Rulemaking (NPRM or “Proposed Rule”) which explains the agency’s plan to address the problem and accomplish its goal. A new comment period follows, after which the FDA issues its Final Rule and announces an Effective Date for compliance. For more specifics on the process, see “A Guide to the Rulemaking Process” by the Office of the Federal Register.

Exhibit 1
Next steps: FDA solicits stakeholder comments via an ANPRM & NPRM, followed by a Final Rule
?????????FDA Review Procedure

Next Steps in Moving Toward Implementation of a Potential New Nicotine Strategy
???????Step FDA Rulemaking Process Description Timing / Other
1.
2.
3.
??Advance Notice of Proposed Rulemaking (ANPRM)
Notice of Proposed Rulemaking (NPRM or “Proposed Rule”)
Final Rule
FDA solicits comments/input from major stakeholders to help inform the rulemaking process; FDA responds to the comments
FDA explains the agency’s plan to address the problem and accomplish its goal
FDA issues its final rule (i.e., regulatory standard) and sets an Effective Date for compliance
30-60 days typically, but 180 days or more for complex rulemakings
Opens new comment w indow similar to the A NPRM
Throughout the process, the FDA could reconvene the Tobacco Products Scientific Advisory Committee (TPSAC)
????????Source: Office of the Federal Register

As discussed, this is realistically a multi-year effort, perhaps as much as 3-5 years in our view. While we agree that there could be added incentive for Commissioner Gottlieb to expedite the process given that he may have as little as 3.5 years left in his role as a Presidential appointee (unless reappointed), we think the sheer complexity of the mandate could potentially require more time than Gottlieb has as FDA Commissioner .

What is the Current Science on Nicotine & How Close is the FDA to Having the Scientific Evidence Necessary to Support Its Case? – This gets to the heart of one of the more complex and controversial areas of concern: will the FDA be able to sufficiently ground its effort in science and build enough consensus to avoid: (1) unwanted litigation; (2) unintended consequences, and/or (3) political embarrassment? The critical questions in our mind are: What is the absolute threshold of nicotine addiction? How fast should the FDA reduce nicotine levels in cigs (gradually? immediately?)? While the absolute threshold for nicotine addiction differs by smoker and circumstance, the consensus among researchers and the WHO seems to be that the threshold for addiction is likely close to 0.4mg of nicotine per gram of tobacco (this compares to a standard-strength cigarette at 15.8mg of nicotine).1 That said, a 2015 study published in the New England Journal of Medicine2 found that reducing nicotine levels by at least 85% (to 2.4mg from 15.8mg) led to reduced cravings and compensatory behavior, suggesting this may be the ‘sweet spot’ for regulatory purposes.

Potential Headline Risk 1: FDA Favors Immediate Reduction of Nicotine Levels in Cigs - The problem however is that many studies are relatively short-term (e.g., 6 weeks in the above cited one) and are not necessarily designed to monitor long-term behavior and the potential for smoking relapse. So it raises the next important question: how quickly should the FDA reduce nicotine levels in cigs? We understand that findings from a potentially important study led by Dorothy Hatsukami may be published as early as this fall that could suggest an immediate reduction in nicotine levels by the FDA would be more effective than gradual reduction in terms of discouraging compensatory behavior. This could potentially create headline risk for tobacco manufacturers of conventional cig products and extend the FDA overhang on valuations. We note at least 41 NIH-funded nicotine-related tobacco studies underway this year (see Exhibit 2). We expect funding and research to ramp as the FDA solicits help from the scientific community.

1See WHO Advisory Note – Global Nicotine Reduction Strategy (2015). 2See “Randomized Trial of Reduced-Nicotine Standards for Cigarettes,” published on October 1, 2015, in the New England Journal of Medicine (NEJM).

A 3.5 year timeframe is optimistic, in our view
85% reduction in nicotine levels could be the “sweet spot” from a regulatory standpoint
Recommendations for an immediate reduction in nicotine levels would likely create headline risk for big tobacco
???????????????2 | Wells Fargo Securities, LLC
Tobacco Talk: XXII Mgmt Mtg Takeaways Equity Research

Potential Headline Risk 2: “Stripping” Nicotine Out of Tobacco Could Be Costly & Damaging to Quality –

A regulatory standard that requires a more immediate than gradual reduction in nicotine levels in cigs (should the FDA lean this way) could certainly make it more challenging for the tobacco industry from a cost, timing and even quality perspective. While we have no real sense as to how this will play out, we expect tobacco manufacturers will be faced with the option of either stripping nicotine from their tobacco plant supplies or licensing the technology to accomplish this organically (at the genetic level). While we don’t have a good grasp on what this might cost, we understand that it could potentially cost the manufacturers an incremental cost per pack (possibly around $0.10-0.20/pack per year) to perform this process or possibly license this technology. In addition to cost, another potential downside to stripping nicotine out of tobacco is that the stripping process often strips out more than just nicotine from the tobacco plant, resulting in a degradation of taste, flavor, color, and smell. The alternative is to license the means to have nicotine stripped genetically from the tobacco plant. So far, XXII is the only company we know that owns patents to do this. While we note this as a potential headline risk for MO (MO, 1, $63.42), we remain confident that it can weather the challenge especially as we expect iQOS to make up an increasingly larger part of its total volume (54% by 2025, by our estimates).