XXII - 22nd Century Group Inc. (XXII) Q1 2023 Earnings Call Transcript
2023-05-09 16:08:08 ET
22nd Century Group, Inc. (XXII)
Q1 2023 Earnings Call
May 9, 2023 10:00 AM ET
Company Participants
Matt Kreps - Investor Relations
James A. Mish - Chief Executive Officer
R. Hugh Kinsman - Chief Financial Officer
John Miller - President, Tobacco Business
Conference Call Participants
Aaron Grey - Alliance Global Partners
Victor Ma - Cowen & Company
Alex Fuhrman - Craig-Hallum Capital
Brian Wright - Roth Capital Partners
Jim McIlree - Dawson James
Presentation
Operator
Welcome to 22nd Century Group First Quarter 2023 Conference Call and Webcast. At this time, all participants have been placed in a listen-only mode. The floor will be open for questions following management's prepared remarks. [Operator Instructions].
It is now my pleasure to turn the call over to Matt Kreps, Investor Relations for 22nd Century. Please begin.
Matt Kreps
Thanks, Brian, and good morning and welcome to 22nd Century's First Quarter Earnings Conference Call. Joining me today are Jim Mish, CEO; Hugh Kinsman, CFO; and John Miller, President of our Tobacco Business.
Earlier today, we issued a press release announcing our results for the first quarter 2023. The release, earnings presentation and 10-Q are available in the Investors section of our website at xxiicentury.com.
We'll start today's call with prepared remarks from Jim, John and Hugh before moving into a Q&A session with our analysts. Given the limited time for today's call and Q&A, we will again focus on commercial advancements driving revenue in our VLN tobacco and GVB hemp/cannabis business units. If you have questions about our business not addressed on this call, you are welcome to email Investor Relations using my contact information provided in today's release.
On slide two, a few reminders for today's call. Some of the statements made today are forward-looking. Forward-looking statements are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in our annual, quarterly and other reports filed with the SEC.
Also during today's call, we may also discuss non-GAAP financial measures, including adjusted EBITDA, which we define as earnings before interest, taxes, depreciation and amortization as adjusted for certain non-cash and non-operating expenses. For more details on these measures, please refer to our press release issued earlier today.
And with that, I'll turn the call over to Jim, beginning from slide three.
James A. Mish
Thanks, Matt, and good morning, everyone.
We continue to execute our operational plan to grow the tobacco and hemp/cannabis business and transform to cash positive in 2024. We recognize that there are many key questions from our shareholders that we will answer today. These include, clear guidance on revenues and how and when we get there, VLN distribution, and more important store count and commercial sales, and hemp/cannabis ingredient and distribution ramp up.
We also get a lot of questions about cost cutting. I can assure you that this is a constant part of our discipline to focus dollars only where it leads to our goal of operating profit. Just this quarter, for example, my staff has been reduced by 30%, and we have ongoing cost programs across the business.
Now this said, we will not cost cut our way to success. We are a growth company. We're off to a great start this year on revenue in Q1. And once the business interruption insurance for Q1 is received here in Q2, it will result in most exceeding plan on revenue, gross profit and operating results for the first quarter.
I'm proud of this team, and our continued execution of our plan that will drive growth, margin improvement and operating performance. Recall, that we have been consistent that Q2 would be one we gained real traction on commercial sales of VLN, based on the [right] (ph) planning process and timing of our retailers.
It's important to understand that the VLN rollout follows a detailed process, but it is happening at twice the speed of a typical tobacco product rollout. John, will detail our aggressive commercial rollout of our FDA authorized VLN reduced nicotine cigarettes. This includes a highly anticipated launch covering thousands of stores across California, Texas and Florida with a number one U.S. C-Store chain, supported by national-scale distribution providers. Additional new retail chains are already scheduling product launches planned for 2023 to ensure they're positioned with us.
In our hemp/cannabis business, we're focused on growth initiatives to capitalize on our dominant market position and cannabinoid ingredients in our new sales and distribution services. We again reported record cannabinoid ingredient volumes and recently signed two transformational CDMO+D license agreements with industry leaders, Cookies and Old Pal. Combined, these agreements are worth at least a $140 million in sales over their three-year term with very attractive margins, and additional deals are well into the pipeline.
We're also restoring our capacity lost in the Grass Valley fire and while business interruption insurance will cover our margin impact in Q1 and Q2, we will see significant margin expansion in the second half of 2023 due to this restored capacity. Combining these facts, our confidence in our growth outlook has us introducing our first revenue guidance following for full year 2023 revenue of $105 million to $110 million. This represents a 69% to 77% increase from the $62 million in 2022. Achieving that goal, plus execution on several cost cutting and margin improvement initiatives already in progress, provides us a clear pathway to achieve cash positive operations from both businesses in 2024.
Slide four provides a snapshot of this path. In tobacco products, we've secured major national-scale distribution agreements with the number one and number two distributor that expedite putting VLN into hundreds or even thousands of stores at a time across multiple states. This enables the launch we are working on now with thousands of C-stores in the three largest state markets, and for us to expand our relationship with the number two C-store and also opens up a massive funnel of more than 100 retail chains interested in VLN. Q2 is where the commercial sales and store count will take traction. And recall that we just need to hit an annualized run rate of $1.2 million VLN cartons sales, to generate positive cash flow in our tobacco business unit.
In hemp/cannabis, we continue to deliver record ingredient volumes as the dominant leader. We're driving increased demand for our CDMO services, and have now secured the first two exclusive, fully verticalized sales and distribution agreements with major brands. Combining with several cost cutting and margin improvement programs, we're tracking to our goal of cash positive in the first half of 2024 in this business. So, I say with continued confidence, and stay confidence that we will deliver on the company's full potential and cash positive operations.
With that, let me turn over to John, to discuss our tobacco business activities in much more detail. John?
John Miller
Thank you, Jim, and good morning, everyone. We are rapidly scaling an incredibly disruptive product and on track to move quickly from 500 stores carrying VLN to 5,000, and that's just to get things started. And while the path has certainly changed along the way, and we'll definitely continue to evolve as we learn more about this incredible product, we are 100% committed to success.
Turning to slide six. It's important to appreciate that at this time last year, we were in less -- we were 30 days into our VLN pilot. We need to confirm how best to take this exceptional product from FDA authorization to scalable distribution, to full consumer acceptance. The cigarette category is ultracompetitive. National distribution is a multi-phased, time consuming and complex product and the adult smoker acceptance will be driven through sales and marketing actions that drive awareness, education and trial.
Early sales exceeded industry expectations and drove our continued market research activities and testing through the remainder 2022. I came on board last May and in the fall began to hire our team of deeply experienced tobacco industry professionals to help in our mission to be the last cigarette adult smokers ever purchased.
By December, we knew that there was an opportunity to make a major shift into national-scale distributors with geo-focused retailers, and the sales and marketing activities that will drive consumer acceptance. We understood this process will require some time, but we’d also greatly accelerate our launch capabilities for 2023. We have now done that, and our new launch plans for 1,000 of stores will be the proof that the time, patience, and incredible effort that has taken place behind the scenes these last few months was 100% worth it.
Slide seven explains, why. You've seen this map. What is different is that, we now have the number one and two nationally distributed signed up and shipping allowing us to place VLN into thousands of stores within weeks. This is critical as the opportunities our teams have worked on for the past five months can take us from 500 stores to 5,000 stores in a single agreement and that's a start. This distribution has also opened up the floodgates and retailers are scheduling product launches across the rest of 2023.
This includes not just C-store, but also pharmacy, big-box, club-stores and military sites, all drawn from more than 100 retail chains now at various stages in our sales pipeline, support us growing fast. For example, we have just been approved by the National Coalition of Franchise Association behind one of our key retailers even before a launch. This gives VLN an access to franchise owner groups covering more than 7,500 stores across the country.
As another example of the benefit of taking the time to properly build the national distribution network, we expect to be rolling via out to several Marine Corps Base later this month. The bases are located in Southern California, Arizona and North Carolina. This provides an entry point to expanding with other branches of the Armed Forces domestically and internationally and supports a key Department Of Defense initiative of helping our military personnel reduce smoking. These military facilities are all serviced through our new distribution agreements.
Moving to slide eight. Underpinning this phenomenal market access and acceleration, we have refined and enhanced our consumer marketing based on what we have learned so we can maximize these incredible opportunities. Our research last year helped us to understand how smokers are not just addicted to nicotine but also the act of smoking itself. Further, most current cessation tools only address the nicotine addiction and utilize negative messaging, which works against success by smokers.
VLN offers a new tool, and a positive optimistic approach to reducing smoking. We empower smokers to confidently and capably take control of their habit, break the nicotine addiction and then move away from the behaviors as well. This is a critical distinction for VLN. You'll also notice that the ad sample captures those same strings that set beyond apart, confidence, capability, freedom and the lack of pressure from fear of failure. It's really an incredible opportunity to give the power back to adult smokers, so they can succeed on their own terms.
And turning to slide nine. As part of getting the word out about this incredible new tool to reduce smoking, we're going heavily digital with Hyper-Targeted Awareness Campaigns designed to educate and encourage trial. We can be very precise with our placements, reaching just our target audience or key influencers by utilizing videos, native, banner and image ads. These and other dynamic engagements are designed to convey the VLN product position, value proposition and reinforce brand credibility. One of the things we learned is that, many smokers are absolutely interested in switching once they learn about VLN, an incredibly difficult feat with smokers who are among the most brand loyal consumers, gives credence to how powerful VLN can be.
Moving to slide 10, we'll complement that engagement with the revamped brand site, testimonials, continued positive reinforcement and encouragement, plus local PR efforts to generate public awareness and proactive conversations about smoking harm reduction and having a new tool that can help smokers reduce their smoking, by still smoking until they naturally see a decline in their consumption. We're also looking to build and reach influencer communities. In addition to macro social influencers and clinical leaders, it's also micro influencers and peer-to-peer influence such as family members and friends of the smoker, who complain important roles in education, awareness and continued support along this journey.
On slide 11, so, can we do it? That's the key question. And the good news is that, we not only have an incredible runway of exciting new relationships, market data, marketing campaigns and retail stores, we also have a good predicate to demonstrate these channels can work. Pinnacle, is a new premium store brand designed to offer better value to smokers not yet ready to quit, but, it's also a great proof point that we put a new product into thousands of stores across more than 20 states and quickly gain share, which is exactly what we are doing with VLN.
Pinnacle launch of the top five C-store chains with 1,700 locations, rolling out in just weeks through one of our new distribution agreements. Early sales are robust, even before the C-store began promotions, moving toward a run-rate of several hundred thousand cartons per year. This experience illustrates the path for VLN, with more retailers, more stores and a more differentiated story. In short, yes, we can launch with the number one chain across thousands of stores in multiple states, all we need is the green light to go.
On slide 12, we update several other initiatives in-place designed to expand and improve our business results. Many of you are keeping close watch on our international efforts, which are moving forward. We've launched a test in Switzerland, the product has already shipped to our Swiss distributor and the more than 200 targeted stores will receive VLN later this month.
In Japan, we have cleared all major regulatory hurdles and are preparing the shipment to our Japanese distributor to begin a test in approximately 200 stores in June. And our efforts in South Korea continue to move ahead. We learned a lot from the initial program. We've updated the packaging and product attributes to align closely with that market and will again be shipping midsummer for additional retail program.
Slide 13. On the operational front, we're taking actions to improve our margins and profit. This includes rotating out of a lower margin filtered cigar business and allocating greater production capacity to our growth markets in premium products like VLN and Pinnacle. Volumes have already increased the head of retail placement, as distribution centers prepare for their customer sales and replenishment orders. You will start to see this activity in the Q2 results and growing thereafter.
Turning to slide 14, we have talked extensively about the benefit of federal regulation in both the U.S. and overseas and believe these policies are moving close to reality. We believe the first action is the FDA's proposed banning menthol related for final rule status in August. We believe that our VLN Menthol King cigarettes could be the only combustible menthol cigarette on the market exempt from federal menthol ban.
Longer term, a federal reduced nicotine content mandate such as that adopted by New Zealand would be even more effective in reducing the harms of smoking. We are excited about New Zealand's groundbreaking policy, as not only a great policy for their country, but as a template for other countries to pursue similar action. We announced the seed growing programs efficient to supply the entire New Zealand cigarette market, approximately 2 billion sticks. This shows that it's not only feasible but actually workable, to scale-up a full federal reduced nicotine program in a relatively short period, a massive opportunity for public health benefit.
So, bringing it all together on slide 15, we're rapidly accelerating toward our goal of achieving cash positive results in 2024. We are driving to exponentially increase VLN's availability. We're leveraging our new distribution agreements, and an incredible pipeline of retail stores wanting to carry the product. These efforts are backed by a new consumer awareness, marketing, engagement and influencer campaign designed to empower and affirm smokers, encouraging them to take control and achieve success.
Our campaigns will support the adult consumer, positively reinforce our efforts. And along the way, we are optimizing our operations to transition our capacity toward these better margin growth opportunities, scale of VLN capacity and generates results for our investment in the team driving the VLN ramp. Success here drives scale, margin improvement and ultimately cash positive results in 2024.
With that, I'll hand it back to Jim.
James A. Mish
Thanks, John. It's really an incredible update and should give everyone listening a clear understanding of the massive amount of activity and line-of-sight to revenue in our VLN programs.
I'm excited to say we're also seeing similar results in our hemp/cannabis division. Starting on slide 17. GVB is the market leader in North America for the manufacturing of hemp-derived active ingredients and finished products servicing the consumer packaged goods, nutraceutical and pharmaceutical industries with a global footprint. Sales have ramped strongly, and we believe we'll continue to do so driving the cash positive operations in the first half ‘24. This is driven by key actions in motion.
First, we continue to set new records for ingredient volumes and sales delivered quarter-after-quarter.
Second, our new CDMO plus distribution model provides a complete vertically integrated solution between 22nd Century and brands.
Third, our new extraction unit is online, and a new distillate unit is coming online in Q2, putting us on track to replace capacity and recover margins following the Grass Valley fire last November.
And fourth, we're taking several other actions to both ramp-up our volume capability, and reduce cost to improve profitability such as new contract farming of our own hemp biomass.
Moving to slide 18. We continue to set new records in ingredient delivery each quarter, and don't see that trend slowing. This quarter, we delivered more than 68,000 kilograms of ingredient. This is four times what GVB delivered in the quarter a year ago. And we see continued growth ahead even beyond this exceptional number.
This has placed us in a dominant position for North America and our deliberate decision to ensure we maintained all customer deliveries and volumes. Even at a short-term cost to our margins, was absolutely the right path, especially when the first business interruption insurance is received in Q2 applicable to Q1 gross profit. And I want to point out again, that we're doing this without our in-house production facilities. So, as our own capacity comes back online, those margins will return to positive territory. We can further improve them through our internal optimization efforts already in motion.
On slide 19. We announced last week the second of our transformative CDMO+D agreements, now encompassing both industry leader Cookies and the well-known Old Pal brand. These exclusive license agreements cover branded hemp-derived cannabinoid consumer products and accessories.
22nd Century provides single source integrated production, sales and distribution leveraging our industry-leading formulations, ingredient and manufacturing infrastructure, plus the company's turnkey sales and distribution platform for a complete go-to-market solution. The brand can then focus on customer engagement and marketing, while we provide expansive access to mass market channels urgently seeking new high margin products to meet growing consumer demand.
I continue to think that the market has underappreciated this opportunity, as we estimate the combined value of our two agreements signed to-date is potentially more than $140 million, a significant increase in revenue over the next three years from just the first of these opportunities.
On slide 20, making those agreements possible is our industry-leading infrastructure. We believe that as our world-class extraction facility in Prineville scales that will displace our third party crude purchases in the market. Our new distillate facility in Prineville will be online this quarter with isolate production capacity to come in either late ‘23 or very early ‘24. Our new campus approach will increase total capacity, efficiency and productivity generating a better capability than our original facilities.
From there, our 40,000 square foot Las Vegas manufacturing site will leverage our VLN market sales and distribution teams for the new CDMO+D agreements. We've also opened new facilities in Europe and acquired RXP in the UK to create a strong foot print for landed ingredient sales in the higher margin European market.
And finally, slide 21. Bringing it all together, we are tracking to exciting growth in a clear path to cash positive operations in the first half of 2024 for this business unit. We'll do that, by a steady and dedicated focus on operating performance enhancement, internalizing and capturing margins across our growing volumes, plus the new CDMO+D business agreements that significantly scale-up our revenue, and enable us to capture greater share of the margin chain.
We're augmenting these immediate actions with developments for the future including path to pharmaceutical sales, as new facilities come online and positioning for the future food and nutraceuticals market opportunity, once FDA and Congress establishes the new regulatory pathway. And our success is not dependent on this. This is all upside.
With that, I'll turn it over to, Hugh, to cover the financials. Hugh?
R. Hugh Kinsman
Thank you, Jim, and good morning to everyone.
Starting off on slide 23 with first quarter financial results. Net sales increased 144% quarter-over-quarter to $22 million reflecting the addition of GVB revenue. Net revenues are expected to increase steadily through 2023, driven by increased VLN sales, growing GVB bulk ingredient revenue, and new CDMO distribution agreements.
Gross profit is projected to improve significantly in Q2 2023, reflecting higher margin product mix for tobacco business unit, as well as the return of production capabilities, the establishment of farming program and new distribution agreements for hemp/cannabis.
Moving to slide 24, tobacco revenue for the first quarter remained relatively unchanged to $8.9 million, with gross profit decreasing to slightly to $18,000 reflecting the planned reallocation of project capacity towards a higher margin product mix including VLN and conventional cigarettes.
On slide 25, hemp/cannabis revenue for the first quarter grew 85% to $13 million from $7 million due to continued strong customer demand for bulk ingredient products. Gross profit decreased to negative $1.2 million reflecting the impact of the Grass Valley fire. The gross profit will improve immediately in Q2 reflecting our new extraction facility and the return of distillate capabilities. And gross profit will continue expanding throughout the year due to the new farming program and return of isolate production in Q4 2023.
On slide 26, you'll see a few key highlights from our balance sheet. Of note, total assets of more than $124 million includes approximately $51 million of goodwill and tangibles from the GVB and RX Pharmatech acquisitions and the balance sheet includes $23.7 million in cash balances including proceeds recently completed $21 million in senior debt facility. The new credit facility will fund increased working capital needs reflecting significant growth in both VLN and the hemp/cannabis business lines. And it should be noted, the company received insurance proceeds of $5 million from the Grass Valley fire in Q1 this year, with additional proceeds of approximately $8 million for business interruption to be received beginning in Q2 2023.
Finally, slide 27 reaffirms our revenue guidance for fiscal year 2023 of a $105 million to a $110 million, both tobacco and hemp/cannabis franchises are tracking cash flow breakeven in fiscal year 2024 reflecting strong demand for VLN product and hemp/cannabis bulk ingredients, as well as accelerated unit sales from our new distribution agreements.
And with that, the operator will now open the call up to any questions.
Question-and-Answer Session
Operator
Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions]. First question comes from Aaron Grey with Alliance Global Partners. Please go ahead.
Aaron Grey
Hi, good morning and thank you for the questions. So, first question for me just wanted to start off on VLN. So, if I see that it looks like you'll be transitioning to more revenue generation for them. Just to give more color, did the shelf resets have an impact there, and are you already in-place for that for your retailers happy with the shelf space that you're going to be expecting there? And then in terms of the revenue growth, you'll be expecting from tobacco off of that $40.5 million base of last year. Looks like based on the graph, it will be about in the low pictures or so. Is that -- how much of that is driven by VLN versus by the Pinnacle? Thank you.
John Miller
Hi, good morning, Aaron. This is John. I can take the question on the shelf, or that we're going to be merchandising yet. Everyone that we're going to market with, we are worked into their sets. We are part of the merchandising, and a lot of them have truly understood the story that we're putting out there about what our brand is about and they want to help provide a solution to those 35 million smokers who want a solution.
So, yes, this is all encompassed within the schematics. And again, talks about the process that I talked about the extensive process, the complexity around it. That involves obviously planograms reset schematics. So, VLN will be part of those debts. And I guess, Hugh, could probably answer the revenue question.
R. Hugh Kinsman
Sure. Will do. Aaron, just to give you some guidance, we're -- significant portion of the incremental increases related to VLN. I'd say probably 60%, 70% of that and the remainder is due to Pinnacle growth.
Aaron Grey
Okay, great. Thanks for that. It's really helpful. And then secondly for me, just in terms of the contracts that you have with Old Pal and Cookies, strong brands in the THC market now transitioning to some of the other cannabinoids. So, as we think about the $140 million over three years. How do we think about the timing and the ramping of that and how it might impact the P&L? Wondering if I ask is because again kind of looking at that topline guidance, it would imply hemp sales again in the low 50s, you guys did about $13 million. So that kind of maintains that 1Q 2023 run-rate. So, not sure if those some shipments that might have impacted the timing that benefited the quarter, that might not repeat or how to think about that segment going forward? Thank you.
R. Hugh Kinsman
Sure. I can take that. So obviously, we recently signed the agreement there and so the shipments will start in Q3 of this year. And it increases pretty rapidly. So, the way to think of it is, I would say, the bulk ingredients are pacing along the lines like you said, it might even be a little higher quite frankly. And we'll start later on the contract revenue as we refined too in the production and supply chain cycle. And then from there, we ramp the business accordingly, especially with the incremental penetration in the retail stores.
So, probably the way to think about it is, ramping slightly in Q3 starting to really ramp significantly on both contracts in Q4, and then I would say I wouldn't call it hitting a steady state because it looks like it'll continue ramping, meaningfully throughout 2024, and probably hitting a steady state sometime and mid-2024 and ramping steadily, but really the big ramp will be in the next two to three quarters for each of those contracts.
Aaron Grey
Okay, great. Thanks. Appreciate the color and I'll jump back in the queue.
Operator
Thank you. And next question, we have Viven Azer with TD Cohen. Please go ahead.
Victor Ma
Hi, good morning. This is Victor Ma on for Viven Azer and thank you for the questions. So first off with the launch of Pinnacle, can you please comment on price positioning given the down trading we're seeing in U.S. cigarettes? Thank you.
James A. Mish
Yes. As we had discussed on the call, Pinnacle is a brand for one of our chains. And they're pricing it, I would say probably the best position is they like probably around lucky strike. It seems to be in terms of that, in terms of their pricing and strategy on that product, not super premium, solely not for tier, but right around that position.
Victor Ma
Great. Thank you. And then can you provide an update on the VLNs launch in the States that you're getting ready for last quarter, namely Arizona, New Mexico and Utah?
James A. Mish
Correct. As we continue to roll the product out and continue to refine the plans, we have had the product in Illinois and Colorado. We continue to make progress in those states certainly still on the radar moving forward with all of those. Specifically, those three states are part of the 18 priority states. That we're going to continue to ramp. And we are continuing to see obviously the retailer demand for that moving forward.
Part of Aaron's question really was very good because when you look at sort of some of the complexity around getting into the stores, it has been about timing. We are subject to reset, schematic changes, planograms. All of that is part of the discussions we're having with these major retailers in those states. So it continues and we feel we are on-track to be exactly where said we would be in those 18 states and probably few others.
Victor Ma
Great. Thank you. I'll hop back into the queue.
Operator
Next question, we have Alex Fuhrman with Craig-Hallum Capital. Please go ahead.
Alex Fuhrman
Hey, guys. Thanks for taking my question. Wanted to ask about as you've expanded to more states, what have you seen in terms of the mix of menthol. And as you think about expanding to states that you have either state-wide or local city fans on menthol, how is your marketing strategy going to be different?
John Miller
Good question, Alex. When we saw 2022 menthol represented about 35% of the market. Obviously, when you have states like California and quite honestly, some of the other local bands, I think on the last call, we talked about over 100 initiatives were in place in the state to ban menthol and flavors and things like that. Certainly, it's having an impact on the category. In terms of mix for us, our menthol has always either been rate at the market level or maybe slightly higher, which is pretty normal, I think, for a new product like this. We're continuing to monitor it. We're continuing to work through it.
And we certainly have put some things in place to try to position VLN as it should be, which is a solution for menthol smokers. One of the biggest issues when you ban menthol is, it doesn't mean menthol smoker stops smoking, 50% to 60% of those smokers just transition to another product. So we're getting the case out in front of the legislative bodies who are looking at this, they're saying why is VLN a solution? Not only on the federal level, but we know it's also important on the state level. So, again working within these -- but even California where we're definitely moving into they've been menthol, but obviously there's still a need for the deal and solution.
Alex Fuhrman
That's great. That's really helpful. Thank you. And then can you comment on now that you've been in more state that have preferential tax treatment for VLN? Are you seeing any kind of a difference in velocity or profits for you or the retailers?
James A. Mish
Well, we're definitely utilizing – and it's different by state. It depends on the state on how the retailer wants to utilize it how we position the product initially in Colorado, we positioned it at par with Marlboro Mainline. We started working with Circle K and Smoker Friendly in Colorado and some different pricing strategies. So we're sometimes using that money now to get maybe a better initial introductory offer or something that for consumers. We're also testing some things in Chicago with Circle K to where we're actually getting the price with Circle K support about what does it look like in Chicago if they were to remove the tax against MRTP products. Now we’re getting a test going on that.
So we're actually -- it's giving us some ability to be flexible. It's giving us ability to try different things. It's getting the message out not only about the product, but also about, how do we get people to try it and repeat purchase, things like that.
Alex Fuhrman
Okay, great. That's really helpful. Thank you.
Operator
Thank you. Next question we have Brian Wright with Roth Capital Partners. [Operator Instructions].
Brian Wright
Thanks. Good morning. I wanted to understand a little bit more about the comments about the processing being -- did I hear that right on the distillate in the fourth quarter? So I just wanted to understand how -- what's going to drive the incremental gross margin improvement in the GVB in the second and the third quarter? And what are those steps to be aware of?
James A. Mish
I can take that one in queue and maybe chime in with the details. But thanks for the question, Brian. Yes, just to refresh everyone's memory, right now, we're purchasing and reselling both the distillate and isolate. The first big impact on margin improvement will come as now our new world scale extraction unit is online and operating. We'll continue to ramp that up. So that makes a big impact on margin improvement. The rebuild of the distillate facility now moving very quickly in Prineville comes online in Q2. So that relieves any of the purchase resale we go internal again. We continue to see margin improvement, dramatic margin improvement on top of that, especially now fed by our own extraction crude material.
And then we've been expediting, bringing the new isolate facility online. We had put a stake in the ground for Q1 of 2024. We see pathways of pulling that forward. And we're executing on that. It's not definitive yet, but I do think we have a good opportunity to get that fully operational by even the end of the year which will further improve margins. So the margin improvement is stacked as we get into even Q2 now with the extraction and distillate and then into Q4, Q1 on the isolate.
In the meantime, for at least Q1 and Q2, the business interruption insurance heavily impacts the financials. It's a bit retroactive because the Q1 sales are covered by insurance that we're receiving now in Q2.
Brian Wright
Great. Thank you. And then just wanted to understand you had made some comments about some cost efficiencies and some reductions and just – was that just your staff or were there broader actions and just any quantifications on efficiencies there?
James A. Mish
Yes, it's more of a constant process across all the functions, all the business units -- both business units. We're looking for every opportunity to control our costs in a very disciplined manner and making every attempt to make sure every dollar goes towards our single goal, which is operating profitability.
So it cuts into every function. It cuts into every location. And it takes many different forms, whether it's attritional loss that we're not backfilling. We’re taking proactive measures on the SG&A basis or on CapEx programs etcetera. So every dollar spent is under very high scrutiny for both myself and Hugh and John and others. They are their functional leaders, whether it's innovation, etcetera. So we're looking for every way to control our costs. We know there's not an endless stream of capital out there, especially in today's market. And our intent is to drive this towards operating profit with no further dilution. So it's all hands review on a weekly basis to make sure every dollar is being maximized.
Brian Wright
Great. Thanks. And then just one last one if I could. The VLAN sales by the end of the year are going to be pretty significant as far as the overall tobacco business. And just like have you thought about like timing as far as when you think you'll start, officially breaking out those sales?
John Miller
Yeah. I think that's probably a very good question, Brian. I think we'd prefer to kind of get it into a little bit more of a steady state to such a significant incremental ramp for VLN over the next two to three quarters sequentially. So probably, yeah, there's thought that we probably start breaking out separately sometime Q3 -- Q2, Q3 next year.
Brian Wright
Okay, great. Thank you so much.
Operator
[Operator Instructions]. Next question, we have Jim McIlree with Dawson James. Please go ahead.
Jim McIlree
Yes. Thank you and good morning. So in in Q1, you did 68,000 kilograms of bulk ingredients. Once you get all of your reconstruction and construction plans completed, what will be the bulk ingredient capacity relative to the Q1 levels. Are you just replacing what you've been buying online or is it going to be replacing and adding?
John Miller
Yeah. I can take that, Jim. We'll have capacity once we have all of our you know, disciplined isolate capabilities including obviously, our crude extraction capability online equal to up to, and of course, a lot of its incremental. We can always keep layering on the incremental capacity going forward. But we'll have capacity to produce that first quarter and probably five times as much if you wanted to on a run rate basis.
Jim McIlree
Okay. That's helpful. Thank you. And can you help me understand what gross margin you think you will exit 2023 and 2024 at for both the hemp and the tobacco business?
John Miller
Yes. I'd say for hemp tobacco 2023, so much of its weighted towards the back end as far as margin expansion for the reasons that Jim had mentioned. But that probably somewhere in high single digits again, if you take fourth quarter and run rate that, it would be much higher. Going out of 2024 it would be -- because we'd have full year benefit of return of all our function capacity that's in the -- not to mention the farming program, which caps at per unit, raw material cost is significant. That is in the 20% probably in the 20% and possibly moving towards 30%.
And then tobacco, 2023 again because we're ramping up VLN and it's happening mostly in a second half of the year relative to Q2 and the second half of the year. We're going to see that plus the fact we have Pinnacle and other tobacco products that are higher margin than say just the filtered cigars, yeah, that margin will still expand to heading 20%. And then it's going to be much higher than that going 2024 is the weighted average -- the majority of the weighted average sales are going to be geared towards VLN.
Jim McIlree
Understood. Great. Thank you.
Operator
Thank you. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.
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22nd Century Group, Inc. (XXII) Q1 2023 Earnings Call Transcript