Welcome to the 22nd Century Group's third quarter 2022 conference call and webcast. At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions following management's prepared remarks. If you'd like to ask a question at that time, simply press star one on your telephone keypad. If at any point your question has been answered, you may remove yourself from the queue by pressing star two. We ask that you please pick up your handset to allow optimal sound quality. Lastly, if you should require operator assistance, please press star zero on your telephone keypad. It is now my pleasure to turn the floor over to your host, Mei Kuo, Director of Communications and Investor Relations. Please begin.
Thank you, Rob. Good morning, and welcome to 22nd Century's third quarter earnings conference call. Joining me today are Jim Mish, our Chief Executive Officer, Hugh Kinsman, our Chief Financial Officer, and John Miller, President of our tobacco business. Earlier today, we issued a press release announcing our results for the third quarter of 2022. The release, earnings presentation, and 10-Q are available in the Investors section of our website at xxiicentury.com under the Events subheading. We'll start today's call with prepared remarks from Jim, John, and Hugh before moving into a Q&A session. As a reminder, those joining by webcast can submit questions through the online interface, which we may include during the Q&A section of today's call, time permitting. 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. During today's call, we may 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. With that, I'll turn the call over to Jim, beginning from slide three.
Thanks, Mei. Good morning, everyone, happy election day. I've spoken at a number of recent conferences, I'm going to keep my opening comments brief, we can get to the details quickly. I will say it's been an incredible few months since our last quarterly update, there are more exciting topics to discuss than we can fit into our call today. We're going to focus our time on commercial activities of our rapidly expanding U.S. tobacco business and our global scale hemp cannabis ingredients and CDMO business. I'm joined today by John Miller, President of the Tobacco Business Unit, and Hugh Kinsman, our CFO. First, since our last call, we have aggressively expanded our exceptional VLN pilot results by moving into a multi-state commercial launch designed specifically to leverage our awareness, education, and trial approach.
We've advanced from our Chicago pilot to expanding across Illinois to our first statewide multi-partner launch in Colorado, and now announced three additional statewide launches to complete the Four Corners region. This is just the beginning, as we intend to grow our presence in now up to 18 states over the next 12 months and take a notable share in these markets. John will detail this more in a moment, but I can't be more excited about our prospects. We have an unstoppable expansion blueprint driven by consumer interest. We can reach a 1% share milestone quickly where we decide to go. We have a plan to cover over 50% of the addressable market within 12 months. Second, we have now integrated GVB Biopharma, a top-shelf ingredient and CDMO provider in the hemp cannabis-derived ingredient space.
This catapulted us into a fully commercialized and growing hemp cannabis business with increasing margins. We're moving quickly to complete certifications that will further differentiate our products and make us the dominant global supplier of hemp-derived ingredients. I'll come back to this detail after John. Finally, our financial results are driving long-term growth, margin expansion, operating leverage, and cash generation. Our balance sheet is fully funded to support our existing business plans, and we're closely monitoring our investments to rapidly drive share, scale, and financial returns in our commercial pursuits. The chart on this slide illustrates the quickly developing revenue scale in our business that will ultimately drive us to cash positive flows as we complete this carefully planned commercial launch and investments. With that, I'll let John dive into the incredible work he and his team are doing in the tobacco business. John?
Thanks, Jim, and good morning, everyone. It's definitely an exciting time at 22nd Century, and we are moving rapidly to bring an incredibly disruptive product to market. Starting on slide five, our Chicago pilot with Circle K generated exceptional results in a very short time, especially when compared against normal industry expectations for a new product launch. We also tested a range of offers designed to drive increased share through trial and repeat purchases. With that data, we have sharpened and refined our launch plans for our multi-state rollout. We are now fully immersed in our commercial push into the $80 billion U.S. retail tobacco market. Capturing even a very small percentage of this market will be transformative for 22nd Century and our revenue line.
Phase III includes not just adding states, but also bringing on new partners to execute the distribution, training, stocking, and ground support for a growing list of retail sites. This allows for efficient management of overhead while covering entire states with full-service retail programs and support for VLN's rollout. Since some of our new partners have authorized VLN, not only bring potentially hundreds or thousands of store locations, but also represent an accelerated opportunity in the next state where that chain has a presence. In short, our retail launch efforts become efficient, faster, and more productive as we move forward by leveraging a frictionless go where we go partnership approach. Moving to slide six, let me illustrate that a bit. Our current five states represent about 7% of the total U.S. retail cigarette market, or about $5.7 billion at the register.
Just getting a 1% share would be approximately 3.8 million packs of VLN on an annual basis. Three of these five states have favorable MRTP excise tax structures that can further leverage components of our launch programs for adult consumers and our commercial partners. We started with Circle K in Illinois, a fantastic partner who has fully supported our mission. They also supported our expansion into Colorado, where we added Eagle Rock and Krieger Mercantile to distribute VLN into even more stores across the convenience, grocery, pharmacy, and other channels. As new retail partners come on board via our sales and marketing programs, those accounts can go where we go in the other four corner states where we are launching right now. As an example, Circle K, in addition to Illinois and Colorado, also authorized VLN to be sold in all their New Mexico stores.
This is just a starting point. As we rapidly expand VLN's availability, grow our market share, and increase revenue throughout the next 12 months by securing distribution in a total of 12 to 18 states. Let me share with you what that can look like on slide seven. The U.S. cigarette market is concentrated, and we have adapted our accelerated launch plan to take advantage of this concentration. Getting into just 18 states can provide access to more than half the total U.S. cigarette market. That's access to more than $39 billion in cigarette sales in the highlighted 18 states. You can see on the map that our five current states, Illinois, Colorado, Utah, Arizona, and New Mexico, include three states that offer the MRTP excise tax benefit. These are color-coded in light green. Five other states have passed MRTP tax program with similar benefits.
Michigan, Washington, North Carolina, Kentucky, and Connecticut. More states have proposed MRTP legislation. The MRTP states are compelling market opportunities in their own right, but connecting them with adjoining states allows us to create large regional markets and extend the reach and benefit of our marketing, PR, and awareness investments. We'll choose which states and in what order as we continue to move ahead, but understand that we will continue to deploy our model of distribution partnerships, awareness campaigns, and education efforts with retail partners who share in our commitment to improving public health as we build share and revenue. Moving over to slide eight, I want to get a little more granular and help you understand that we can focus our marketing investment in ways to be even more efficient by looking at key market and population centers within the states.
For example, in Colorado, where we are actively in the launch phase, there are 64 counties statewide, but the top 10 counties are home to more than 82% of the population and almost 79% of the state's cigarette volume. By targeting much of our marketing spend and consumer engagement efforts in just 11 of 64 counties could give us access to 80% of the state's cigarette purchases, while at the same time, we'll deploy an appropriate amount of resources in the other 53 counties that are less populated. This enables us to focus our marketing spend and maximize return on investment on our launches. Finally, on this slide, as we discovered in Chicago, a tobacco cigarette that is FDA authorized to help you smoke less is truly newsworthy. During the Chicago pilot, we earned significant coverage that helped adult smokers learn about VLN and how it helps them smoke less.
This has been proved out again in Colorado, with more than 15 segments focusing on VLN having been aired on Colorado television news stations. Slide nine shows how all this comes together in our Four Corners efforts. With an adult population of more than 13 million and a total retail cigarette market valued in excess of $3 billion, we will target more than 7,000 key stores across dozens of retail brands. We'll secure both traditional partnerships like Smoker Friendly and non-traditional partnerships like Eagle Rock and Krieger Mercantile, who want to join us in our mission to reduce the harms of smoking. Where it is available, we will use favorable excise tax legislation to drive market adoption and incentivize our partners to maximize their VLN opportunity.
Our success in ramping up volume mean we have to scale our tobacco growing and manufacturing capabilities, which we address on slide 11. Slide 10, excuse me. We previously announced a record planting season and an expansion of our manufacturing capacity by 25% as we ready for volume increases. It's more than that. We're diversifying our growing locations to include the Southern Hemisphere and working to continually improve our planting results and products. For example, our recent VLN 2.0 tobacco harvest demonstrated a 30% improvement in yield, enhanced leaf quality, improved disease resistance, reduced nutrient requirements, and improved stability across growing locations and environments. Our leaf inventory is scaling quickly, generating higher yields, and improving in quality. We are prepared to drive manufacturing volumes to meet any level of market demand needed.
This is especially important given the increasing movement by regulators at the state and federal level to deploy new policies that can favor our reduced nicotine content products, illustrated on slide 11. Most notably, we have talked extensively about the federal regulations, including a proposed ban on menthol products and even a reduced nicotine content mandate. State and local governments are not waiting for federal action, as noted by the current eight states with MRTP reduced excise tax statutes. We believe that our VLN Menthol King cigarettes could be the only combustible menthol cigarette on the market exempt from the menthol ban, which was specifically contemplated as part of our MRTP authorization. Even more, the science shows that a reduced nicotine mandate would help all smokers more easily quit smoking or migrate to less toxic products.
We currently have the only product that meets this standard with the clinical data to back it. 22nd Century's research cigarettes continue to fuel numerous independent scientific studies to validate the enormous public health benefit identified by the FDA that would be achieved by implementing a nicotine standard. We believe it is only a matter of time on these fronts, we are ready to help smokers leverage these policy opportunities to truly smoke less. We are moving quickly and plan to continue our accelerated rollout in order to get VLN into the hands of as many adult smokers as possible. I'll now pass you back to Jim for an update on our hemp cannabis franchise. Jim?
Thanks, John. It's been an amazing third quarter for tobacco progress, and we're just getting started. I just have to pause for a second and just repeat some magic words. Unstoppable expansion blueprint driven by consumer interest. It's just been amazing progress that John and the team are making. Let's turn to slide 13 now as we focus for a few minutes on our commercial progress in hemp cannabis. You've seen this slide before, discussing how GVB completes our capabilities from the most fundamental elements of plant genetics and receptor science all the way through to white labeling products on the retail shelf for purchase. We stand alone in the world with this level of breadth of expertise. More importantly, GVB is already the world's largest hemp cannabis ingredients merchant market supplier with the lowest cost, largest scale, and highest quality.
This platform is a tremendous growth opportunity with minimal investment, a process that we are undertaking at a lightning pace. It all starts with the assets we acquired, a fully integrated manufacturing chain that slots right into our plant science platform. This starts with a world-class extraction facility in Prineville, Oregon, that will start out at 5,000 kilos per month capacity and grow quickly with our investment program already underway with an expected output capacity of 15,000 kilos per month in 2023. As this facility scales, it will displace a majority of our third-party crude purchases in the market. We will then take that crude material into our 30,000 square foot crude refinement facility where we expect to see a substantial increase in gross margins as Prineville expands, producing global leading quality cannabinoid isolates and distillates.
From there, our 40,000 square foot manufacturing site can produce an extensive variety of white label products for our customers in the nutraceutical, consumer products, and pharmaceutical industries. The acquisition gives us a strong revenue position in hemp cannabis, a growth platform as an industry leader, and a pathway to increase our gross margin profile and accelerate our path to profitability in hemp cannabis. Slide 15 brings it together to show how we take our hemp cannabis business to the next level of global leadership. First, our Prineville crude extraction facility will enable us to buy biomass and produce our own crude rather than buying crude on the open market. This is a massive cost reduction and will enable us to quickly scale gross margin on our operations as this facility scales up.
We are ultimately targeting a 50% increase in our gross margins from the current levels as a result of this relatively modest investment, while also increasing scale and quality even further. Second, FDA is moving steadily towards establishing novel food product standards for the CBD industry in 2023, including both quality standards, key to certifications, and daily recommendations for intake that will unlock a massive consumer goods and nutraceutical market. In addition to our leading role as the world's largest producer of these active ingredients, we're now acting to secure the product and the facility standards that will enable us to become the dominant supplier to these brands. This includes pharmaceutical-grade certifications for both of our facilities of core cannabinoid APIs.
In other words, this puts us in the pole position in an exponentially growing global consumer market and also reinforces our CDMO capabilities, where we have exciting news to come soon. Moving to slide 16, we target that by the end of the second quarter next year, we'll have a full drug master file audit complete giving pharmaceutical-grade certification, enable us to supply cannabinoids into clinical pharmaceutical activities under the highest certifications in the world. It will also give us the edge as a leading global ingredient supplier. We believe that we can generate double-digit growth in this business, expand gross margins, and take the business unit to cash positive in 2023, helping self-fund our growth efforts across our corporate platform.
While a lot of attention is understandably focused on our rapid expanding tobacco business, our hemp cannabis products are also scaling fast and have tremendous opportunities for margin expansion and cash flow in the near term. Those are a lot of words, I just want to summarize one more time because it's an exciting perspective in cannabis. We are already the world's largest merchant marketer of hemp cannabis ingredients. We already have the lowest cost, largest scale, and highest purity. Now, the new extraction unit only adds to these three differentiators and allows new certifications that lead to global dominance. Timing is perfect as the FDA advances to novel food regulations in 2023 that unleashes a massive market opportunity. With that, let me turn it over to Hugh to discuss the financials.
Thank you, Jim, good morning to everyone. Starting off on slide 18 with third quarter financial results. Net sales increased by 149% quarter-over-quarter to $19.4 million, which reflects the addition of a full quarter of GVB revenue and record tobacco CMO manufacturing sales.
We continue to experience significant customer demand for our tobacco and hemp cannabis products, including higher CMO cigarette volume from new customers, in addition to the acceleration of VLN product sales. Gross profit increased slightly quarter-over-quarter to $619,000, as improved gross margin from CMO manufacturing was offset by lower margin from hemp cannabis sales, reflecting certain non-recurring charges. I'll explain gross profit further on slides 19 and 20. Moving to slide 19, tobacco revenue for the third quarter increased to a record $11.5 million from $7.8 million, an increase of 48%. Gross profit margin on tobacco sales increased to 5.5% through a combination of strong unit sales growth and improved product mix from higher margin CMO and VLN cigarette sales. We expect continued gross profit margin expansion to be achieved with the accelerated launch of VLN.
Moving to slide 20 for hemp cannabis, which reflects a full quarter of GVB's operations, revenue grew 25% to $7.8 million for the third quarter. This revenue growth reflects an increase in unit sales of over 80% due to strong demand for the company's premium quality bulk ingredients. Excluding certain non-recurring charges and the impact of purchase price accounting, GVB's pro forma gross margin was 8.1% in the third quarter. GVB's gross profit margin is typically 15%-20% and will expand as the company becomes more vertically integrated with the addition of the new Prineville, Oregon, extraction facility in 2023. Slide 21 illustrates the updated third quarter GVB acquisition purchase price accounting in more detail. As the footnote from our third quarter Form 10-Q explains, the allocation reflects estimated fair values as of the date of the acquisition, which are determined using significant estimates and assumptions.
We have substantially completed the valuation procedures required to allocate the purchase price in areas such as property and equipment, intangible assets, deferred taxes, and goodwill. However, further changes may occur in the future, which may be material. Last from me, on slide 22, you'll see a few key highlights from our balance sheet. Another note, the total assets of more than $140 million includes the $44 million of goodwill and intangibles from the GVB acquisition. The strength of our balance sheet, including a quarter-end cash balance of $44 million, will support our near-term strategic initiatives, primarily the accelerated launch of VLN. I know that many of you are focused on our cash position and how we're using it to continue our steady progress toward profitability.
The company is selectively deploying capital to accelerate the launch of VLN, expand tobacco manufacturing operations, invest in GVB's production capacity, and increase inventory levels to meet growing demand for both hemp cannabis and tobacco products. 22nd Century's cash requirements are anticipated to decrease, reflecting higher sales volume for VLN products through fiscal 2023 and continued organic growth of GVB's operations. In fact, GVB is on pace to becoming a cash-generating business in 2023 due to the investments we are now making to meet market demand. As a result, the company has adequate liquidity from the current balance sheet to complete its strategic initiatives. With that, I'll pass you back to Jim.
Thank you. It's an exciting time for 22nd Century as we accelerate our U.S. VLN launch with several major national C-store and pharmacy chains placing our VLN products in front of customers. With our exceptional pilot exceeding our internal expectations and a massive market opportunity, even a relatively small share of that market is transformational to us, as John described, and as you've recently heard me describe in recent conferences. With a proposed menthol ban moving ahead as it should, plus state actions in advance of federal policies, there's never been a better time for a disruptive, reduced nicotine content product.
We're ready to go, not just on our innovation tobacco products, but also on our hemp cannabis products and new GVB platform that doubles our revenues now, that is fully integrated and enhances our path to profitability as we plan to capture and leverage all the synergies of our two businesses in the months ahead. We built the framework and foundation, and we are now in full execution mode and focusing on business fundamentals to advance to the next phase of our strategy and maximize the full potential of 22nd Century. With that, Operator, please open the call for questions.
Thank you. At this time, we'll be conducting a question and answer session. If you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. We will take questions from the approved list of analysts first. If we have time, Mei will read a question that was submitted via webcast. Our first question comes from the line of Vivien Azer. Please proceed with your question.
Hi. Good morning. Lots of great detail on your aspirations to further expand VLN. Jim, you noted a target for 12 to 18 states over the next 12 months. Obviously, it's a reasonably wide range in terms of incremental volume penetration to as high as 53% at the upper end of that. What are going to be some of the key factors that inform whether you hit 12 states as opposed to 18? Thanks.
Yeah. Hi, Vivien, I'll let John comment on this as well, but I'll give you my perspective because even a few weeks ago, we were targeting 12 to 15. That number has gone up. To add on three more states, that takes us over the 50% mark. It really is driven by supply chain. We want to make sure we're not ahead of ourselves on the supply chain based on growth cycles and the timing of the shelves. I think that's really the major driver. We're going to move as aggressively as we can to the full 18 as quickly as we can. We are making sure that we keep our supply chain all the way back through the ag side in mind as we continue on here, because we certainly don't want to face any stock out situations once we do launch.
I'll ask John also to chime in on that commentary.
Yeah. Thanks, Jim. Good morning, Vivien. It's a good question too, about how do we come to the 12 to 18 states. There's no doubt that there's certainly analytical work that's been done on choosing the 18 states. Really, as Jim's been very transparent in the past, changing the conversation to what we're trying to achieve through these states. What have we taken from the pilot? What have we learned? How do we then implement that in a very pragmatic geographical approach to the business? The 12 to 18 states that you saw on the map that we showed represent about 53% of the total cigarette market.
In the beginning, or I should say maybe last call, there was a lot of questions about a national launch and how do we get nationally, when our team was internally working on exactly what does that mean to have the sort of scope, scale, and presence to make an impact in the market. This is where we've begun, right? You started in Illinois, you moved to Colorado. The Four Corners approach gives access east, west, north. Again, expanding through the pilot program in the Midwest, understanding the opportunities in the Southeast, taking advantage of MRTP taxes in Connecticut and potentially in the Tri-State area.
It's a very pragmatic approach of how we get to meaningful levels in the best way possible, doing the analysis and research that shows this is where the opportunities are, this is where the consumers are, and these are our partners who can get us there. I hope that answers your question.
Yeah, it sure does. That's really helpful. As we kind of think about modeling the tobacco opportunity on a go-forward basis, clearly there are going to be two components to revenue realization. One is sell in into new states, and then the other being repeat in quasi-legacy states, albeit nascent, where it does seem like you have plans to bring on incremental points of sale to deepen your penetration geographically as well. Do you think that the sequential growth that we saw in terms of absolute revenues between 2Q and 3Q is a good framework to keep in mind as we model the opportunity going forward, at least over the next, call it, three to five quarters? Thanks.
Hugh, would that be?
Yeah, I'll take that. Yep. Hi. Good morning, Vivien. Very good question. I think part of it, we had a big step up because we had a full quarter this quarter for GVB revenue. I think when you're thinking in terms of modeling, let's just take tobacco operations. Some of that was just a significant increase in our CMO manufacturing. We expect to have that continue going forward. VLN will start rolling into the velocity of the VLN sales will start to accelerate going into the end of this year, this fiscal period, and then go starting Q1 2023. For purposes of modeling, keeping kind of the growth rate incremental quarter-over-quarter, which would be steady, if you will, which would be comprised of CMO revenue, and then I would start layering on some incremental growth for VLN as we continue to accelerate the rollout strategy.
That's super helpful. Thank you so much.
Thank you.
Our next question comes from Aaron Gray with Alliance Global Partners. Please proceed with your question.
Hi. Good morning. Thank you for the questions, and thanks for the detail. A question I have on VLN, just as you expand some of the new markets, and obviously, in Chicago and broader Illinois, you had a great partner in Circle K to help in terms of displays and shelf placement. I just wanted to get some more color in terms of, as you go to Colorado and these other states, obviously you're going to have Circle K there, but as you lean a little bit more on distribution, can you talk about how you're looking to ensure that you have similar shelf placement at displays, at retail to kind of reach that 1%+ that you got in Chicago and these other markets? Thank you.
Thanks, Aaron, for the question. It's a good point to start talking about what the retail environment looks like. Quite honestly, in Colorado, we have a very similar program with Circle K that we had in Illinois. As I mentioned in our opening remarks, we've also expanded with Circle K into New Mexico. Again, that's a lot of the strategy, right? How do you take the learnings and how do you take all the things that we tested and can take out of a pilot and then move that into a much broader array of stores? For Circle K Colorado, they basically mirrored what we've done in Illinois to a large degree, and then rolled that right into New Mexico. Those learnings, those things will be learned about, and we call it awareness education trial.
All those things that we learned on how we get through that three-step process to trial and adoption, those are the things that we're explaining to retailers that they're working with us to achieve. This isn't like a challenging discussion. I mean, when people understand exactly what we're doing, they understand sort of the difference in VLN versus a traditional cigarette and what we're trying to achieve with this brand, when they see it
Understand what we tested and now what we're putting into market, it makes total sense. To get that awareness campaign going, what does it take? What does it take to make the consumers become aware of it, to educate them on what the product does, to get them to try it, to come back and have a repeat purchase? All of those things are now factored into our retail programming, which is exactly why we're doing this approach to how we're going in a geographical, pragmatic way. I've said it multiple times, this is not a traditional cigarette launch. This is not just a line extension of Marlboro or another very well-known CPG brand. This is a product consumers have to know what it is and what it does. All of that is tied into what we're doing, our partners are understanding that.
A lot of the learnings that came out of the pilot also include the go where we go approach. We're not going to our retail partners and saying, "Give me every store on day one." There are brands that do that. For this brand, you can't do that. This brand is, again, this sort of pragmatic approach, going deep into markets, understanding where the consumers are, which was the example in Colorado, right? 10 or 11 counties, which we really have to execute in to get to 80% of the volume. To do that deep approach into the market, the retailers are understanding this. The go where we go makes sense to them because we know what we have to do to be successful in the market.
Great. Thanks for that. That's really helpful color. I'm glad to hear that retailers have been receptive. Second question for me, I want to talk about GVB a bit. Now that it's been under the company umbrella for a bit, when we go back to when the acquisition was made, you guys talked about revenues being $48 million for the year 2022, gross margins of 44%. Obviously, if you look at the filings, it looks like year to date, had it been closed January 1, you're at $23 million, so below that mark on the sales. You talked about the gross margins, 15%-20%. Last quarter, you had mentioned 20%-25%. Just at the high level, want to maybe take some learnings, maybe there was some more noise from the acquisition once you got under the hood than you had previously expected.
Would love to get more color in terms of how you see the acquisition now a couple of months, post acquiring it, versus maybe some thoughts you had initially. Thanks.
Yeah, sure. I can start out, and then I'll ask Hugh to chime in as well. I think the thoughts at this point, post-acquisition, is that it's everything we anticipated and more. We certainly knew we were going to go through the typical quarter of integration, which we did here in Q3. That takes effort across all different functions, including the commercial side, getting everything tied out. We were expecting perhaps a softer Q3 on the volume side, and then kind of a back build going into Q4 and into 2023, which is exactly what's happening, really both on the ingredient side, the cannabinoids themselves, and also very much so on the CDMO side, which was really in a fledgling position when we finished the acquisition back in May. Everything's coming along very nicely across the integration.
We got through that Q3, and now the ramp-up really is looking promising, both on the ingredients and the CDMO side. As I said before, what really will unleash the CBD market, not only in the U.S., but Europe is looking at the FDA to set their safety guidelines on CBD, and that will open up not only the U.S. consumer product space now in legitimate terms, with safety considerations around it and quality specifications around it. That will very likely be adopted into the European theater, which is very much larger just based on population. It's really living up to everything we thought. We spent perhaps a bit more time on the integration within Q3. Already in Q4, we're back onto the pattern that we hoped for, and we really got a truly top-shelf ingredients and CDMO assets and a phenomenal team that's highly energized.
We couldn't be happier with it, and it really did fill out the foundation. I'm not sure if I missed anything, Hugh, from your perspective on the financial side.
No, I completely agree, Jim. I think it's important to mention that just the backlog for the demand we have for special ingredients is significant going forward. That should propel revenue growth, in addition to some more white label contracts, which should be coming online in fiscal 2023. With that and the Prineville extraction facility coming online, there'll be continued margin expansion as well.
Great to hear. That's helpful detail, I'll jump back into the queue.
Our next question comes from the line of Brian Wright with ROTH Capital Partners. Please proceed with your question.
Thanks. Good morning. I wanted to start out with, when I look at the VLN map with the 18 states, in the press release, you talked about focusing on the favorable MRTP states. You looked at the competing factor of adjacencies and state adjacencies. Texas just is flashing a neon red to me. I just want to think about priorities for next states and any kind of color there. What's your response to that kind of analysis, for lack of a better word?
John, you want to cover that?
I'm sorry. Sorry, Brian. My phone cut out for a second. Did you say that Texas was flashing in red?
Yeah. As far as, it's so close to the Four Corner States, it's a big state. I know it's not MRTP, it just kind of seems like that would be a high next priority.
Right. If you look at the map of the 18 states, the light green states are the MRTP states, I think we labeled the prospective priorities launch states, Texas is one of those dark green states. The difference in the map is we're just trying to show where the MRTP states were as opposed to our priority states. The dark green states are definitely priority states. Texas is definitely dark green. Yes, absolutely 100% Texas, the number one cigarette state in the country, is a natural opportunity for us as we develop out and pivot around the MRTP states. Your initial observation is correct. The MRTP states, we have eight of them, how do we build sort of a regional market around them?
In the Southwest, we're calling it, you have the Four Corners and Texas. In the Southeast, you have North Carolina to the north. Florida is the number three state for cigarette consumption, so there is a natural connection there. Georgia and Texas both had MRTP legislation initiated last year, so again, what's the opportunity there if that passes at some point in the near future? In the Midwest, you have Kentucky and Michigan, MRTP states right around Illinois. That became a natural Midwest area. High propensity of adult smokers in those areas. I hope that answers your question, Brian.
It does. Thank you so much. Thank you. If I could have just one follow-up. On the GVB side, just wanted to understand kind of a little bit more about the Drug Master File submission to the FDA, and as far as is there a timing around that and/or just maybe a little more on that process and what's involved in that process?
I can handle that, Brian. Thanks for the question. The submission we're scheduling for Q1. That does two things for us, in essence. Number one, it opens up the door to supply into the ethical pharmaceutical industry for clinical trials. No one can do that at the moment with naturally derived product. That opens up that space. It also then establishes really the highest level of quality, obviously the lowest level of impurities, to our isolate. That really sets the stage to keeping up with the FDA's movement on the novel food safety standards. The first thing they'll do is establish an upper threshold. Nobody knows for sure exactly what that's going to be, but I've heard numbers anywhere from 25 milligrams per day up to 100 milligrams per day that would service the nutraceutical market.
That's the first thing that they'll do in 2023. Right behind that, they will establish the highest quality specifications, and they'll be looking to what's plausible in the marketplace and looking for people to work with them, which we already are, to establish those quality purity guidelines and also specifically what impurities are in there and the stabilization of it. We'll derive advantage off of that via the DMF filing at the same time. It really helps us on pharmaceutical. It simultaneously helps us on novel food, meaning food, beverage, nutraceutical products. As I said, we've heard very strongly that the FDA has really taken the lead on a global basis to establish these specifications, and more than likely, the external European markets, Asian markets, Canadian markets will look to them to establish similar guidelines and expand and reboot, in essence, the CPG market.
That's the timing, and that's really the value to us, right along with our mission, which is we want to have the absolute lowest cost, the absolute largest scale, and continue to push the absolute highest levels of certification. Certainly, pharma-grade CBD and other cannabinoids is where you need to go, and the DMF is part of that process.
Great. Thank you so much.
Sure.
Our next question comes from Jim McIlree with Dawson James. Please proceed with your question.
Thank you, and good morning. Just wanted to follow up on a question Vivien was asking about the contract manufacturing revenues in Q3. Do I understand this correctly that the quarter-to-quarter change in tobacco revenues of about a million and a half was mostly contract revenue?
Jim, it's Hugh. Yes, that's correct.
All right, great.
Mostly contract revenue.
Great. Thank you. Hugh, you talked this 15%-20% gross margin for GVB. I also want to understand exactly what you're saying. You're saying that that is what it would be on a normal basis. Without all of the new manufacturing plants that you have coming online. Is that right? That 15%-20% is probably going to be seen beginning Q4, then as these additional plants come online, we should see an increase as 2023 progresses. Is that a good way to look at it?
That's exactly right, Jim. Yeah, 15%-20% is your typical gross margin, especially just in a steady state. That percentage will start to increase over time as we layer on the fully integrated the Prineville facility. Those will be the right assumptions going forward.
Great. My last question is on operating expenses for the quarter. In the Form 10-Q, it talked about accelerated stock comp accounting for an additional $1.9 million, strategic consulting accounting for an additional $1.7 million. How transitory or permanent are both of those expense levels when we're looking at Q4 and 2023?
The stock compensation is the majority of that is one-time due to an acceleration of payment for a reorganization, if you will. The consulting, it may not be quite at that level, but there'll be some of that going forward just because of the way we're building up our IP portfolio on a go-forward basis.
The strategic consulting is mostly on the IP side, and I assumed it was for the VLN rollout. It's mostly IP, is that what you're saying?
Yeah. It's mostly IP, but there is some of that consulting related to VLN, but it's definitely related to our IP development for our receptor science and plant genetics.
Got it. All right. Fantastic. That's it for me. Thanks a lot.
Thank you.
Our next question is from Alex Fuhrman with Craig-Hallum. Please proceed with your question.
Great. Thanks very much for taking my question. I'm curious, now that you've been in a couple of different states that have different tax treatments for your VLN product, has there been a clear indication of which kind of ways of passing on that pricing have the biggest impact, whether that's just a bigger margin for the retailer or passing that savings on to the consumer? I'm curious if you've had enough experience in different jurisdictions to really have a sense of is that helping to move the needle for demand, or how that's playing out.
Yeah. Alex, good question. The retail pricing aspect of VLN was something we looked very closely at. There's no doubt that there, especially in the pilot, we saw multiple price points. For example, when you get into Cook County and the City of Chicago, there were some stores that we had three different tax stamps on the packs. We were able to look at and do some research on what is the proper retail pricing to at least launch VLN. What we learned through the actual retail programming and then the research projects we did was that the consumers weren't necessarily looking for a bargain or a deal, and that they were willing to play in line with, let's say, a top-tier product like Marlboro or Camel. If we priced it at that, they were okay. Now, all consumers love offers and some kind of deals. Perfect.
We put that into all of our programming as well, certainly under the trade marketing side of our business. Using the MRTP, as you kind of referenced in Colorado. You have the base case, which is we know the consumers, if this provides a solution they're looking for, are willing to pay for it. Also understanding that they want to have an offer when available. When you go into an MRTP state, it gives us the flexibility then of using, let's say, that tax savings to, again, awareness, education, trial. How do we drive awareness, education, and trial? What we started in Colorado was continuing doing what we knew we needed to do in terms of pricing, in terms of promoting at the right appropriate levels, but also taking some of that money and driving awareness, education, and trial.
If you think about, just as an example, it's $6.50 a carton in Colorado. If someone's looking for a way to get off highly addictive cigarettes or smoke less or whatever they're trying to achieve through this brand, it's $0.65 the difference. We found out that it isn't necessarily, but when they know more about it and when they're aware of it, that's what's going to drive trial, obviously, repurchases. Now we've continued, like I say, to factor all of that in. We have a very great trade marketing program going in Colorado. For example, we have Circle K as one very sophisticated retailer, but we also have Smoker Friendly, which is a very sophisticated retailer in a different channel. Smoker Friendly is primarily a discount tobacco channel, and they have incredible systems.
They're able to do these promotions, they're able to do specific carton pricing in different areas. We've tied into all those systems. It isn't a straight black and white answer that says the MRTP gives you a lower retail. It becomes part of a holistic program, as I mentioned in my comments, that benefit the consumer, trade partners, and everyone else sort of involved in the whole ecosystem of getting VLN into the consumer's hands. I hope that answered your question.
It sure does. Yeah, no, that's really helpful. Then if I could just ask a second on the VLN 2.0 tobacco, it seems like you're seeing a lot of success with that crop here. Is the idea that this is going to be the bulk of the VLN cigarettes in the future are going to be using this VLN 2.0, and can you talk to us a little bit about, is it more about improved taste and texture or better yields and lower costs? Just would love to hear more about the success you're seeing there with the second-generation product.
Sure. I can talk to specific parts of this. In a lot of ways, what we're seeing VLN 2.0 in helping is also our sustainability on the brand. Calvin Treat, who's our Chief Scientific Officer, has done a remarkable job, along with our teams, of being able to grow a more sustainable product. As you heard in my opening comments, this is a product that has better yield, needs less nutrients. It's just becoming a better product the more experience they have in growing it. Obviously, it'll be part of the products we have. It'll make it, again, more sustainable, more disease resistant. There's just a tremendous amount of science into how this will help the product. I don't know, Jim, if you have something else you want to add to that, but in general, it's just going to make it overall a more sustainable and better product.
Yeah, the only thing I can add to that is, we're viewing this, that we want to have year-round grow, both Northern Hemisphere and Southern Hemisphere, which we're doing, across all these varietals where we have IP, then can blend as we desire. Again, the feedback's already very good on the product, but this gives us the latitude, both on the supply chain, and on the next generation products as well. That's really what the driver is.
Okay. That's really helpful. Thank you very much.
Sure.
We've reached the end of the question and answer session. I'd now like to turn the call back over to James A. Mish for closing remarks.
Thank you. Thanks again to everyone for joining us today. All I'll say is please stay tuned shortly for our next updates as we continue to expand our VLN launch in the U.S. and move ahead on our cannabinoid opportunities utilizing the GVB platform. You'll be hearing from us very soon. I look forward to talking to you all next quarter as well. Thank you. Have a great day.
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