Turning Point Brands, Inc.

Good morning and welcome to the Turning Point brand's first quarter 2021 earnings conference call. All participants will be in listen-only mode. Lines have been placed on mute to prevent any background noise. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Louis Raffamino, the incoming Chief Financial Officer. Please go ahead.

Louis Raffamino Thank you. Good morning, everyone. This is Louis Raffamino, our incoming CFO. Joining me are Turning Point Brands President and CEO Larry Wexler, Rand Purdy, Chief Operating Officer, and Bobby Lavin, our outgoing CFO. This morning, we issued a news release covering our first quarter results. This release is located in the IR section of our website. www.turningpointbrands.com, where a replay of today's conference call will also be available. In this call, we will discuss our consolidated and second operating results and provide our perspective on our progress against our strategic plan. As discussed, may I direct your attention to the discussion of forward-looking and cautionary statements in today's press release and the risk factors in our filings with the Securities and Exchange Commission. The disclosure outlines various factors that could cause actual results to differ materially from projections or forward-looking statements that may be cited in today's discussion. These forward-looking statements and projections are not guaranteed the future performance, and you should not place undue reliance upon them, except as provided by federal securities laws. And we undertake no obligation to publicly update or revise any forward-looking statements. In the call today, we will reference certain non-GAAP financial measures. These measures and reconciliations to GAAP can be found in today's earnings release, along with reasons why management believes that they provide useful information. I will now turn the call over to Larry Wexler, our CEO. Thank you, Louis, and good morning, everyone. Thank you for joining the call. We started the year with another strong quarter. In the first quarter, revenue was up 19% to $108 million, above our prior guidance range, and adjusted EBITDA was up 57% to $28 million. Revenue growth was led by Accord, ZigZag, and Stoker segments, which were up a combined 27% despite challenging comments from last year's lockdown-related inventory letter. A number of favorable trends that started in 2020 have continued, even as the country has begun to open up. Our zigzag product segment saw another quarter of tremendous growth as we continued to outperform a healthy market with our execution. New product SKUs and e-commerce were strong contributors to growth, and we ramped up distribution of bond wraps during the quarter. We acquired the rights to this brand in the Durford transaction last year. Canada also outperformed, with recreation marketing results now consolidated within this segment. In Stokers, MST drove our gains, as same-store sales growth continued its strong trend. Stoker's remains the fastest-growing brand in MST, according to NSAI, and continues to be well-positioned for the secular shift to the value category. NewGen saw a solid growth during the quarter, despite continued disruption resulting from industry reactions to the PMTA process. Encouragingly, the FDA has stepped up its enforcement efforts issuing warning letters to 31 manufacturers in March after issuing 29 letters in February and 19 in January. We expect continued volatility for NUGEN as the PMTA process continues. In addition, late in the quarter, they benefited from volatility as the industry responded to the looming implementation date of the PAC Act in the second quarter. Customers bought forward late in March and competitors experienced some disruption. The PACT Act is creating further barriers to entry in the vape distribution business as it has increased both the cost and logistical complexities of shipping vape products to customers. As a result, we're expecting more of our competitors to exit the market in the short term, which will create additional volatility to provide optionality for more long-term upside for our business. We were also very excited about our recent investment in Doc Light Brands, which has the global rights to the Bob Marley brand for cannabis and related use. Bob Marley is one of the most iconic brands in the cannabis space and is a perfect compliment to ZigZag. It fits well with our strategy of building one of the best brand houses in the cannabis space. We'll be rolling out the current line of Marley CBD topical products through our distribution infrastructure later this year. with an emphasis on the B2C online opportunity in the early stages. With over $180 million of liquidity in our balance sheet, we remain well capitalized to pursue further investments and acquisitions to add value to our company and enhance our growth profile. Overall, our performance to start the year enabled us to raise our guidance, and we look forward to continuing our momentum. With that, and to add some additional color and perspective on our quarter and the path forward, Let me turn the call over to Graham Purdy, Chief Operating Officer. Thank you, Larry. Let me now give you a quick snapshot of the performance from segment level. Zigzag products saw double-digit growth in the quarter, led by strong double-digit growth in both U.S. rolling papers and MYO cigar wraps. In the U.S., Zigzag Papers' position is the leading premium and overall paper brand strengthened. increasing its market share in the measured universe by 3.5 points year-over-year to 33.3% according to MSAI. This was the seventh consecutive quarter ZigZag has realized year-over-year share growth. All our major product lines contributed to this growth, supplemented by our new products and our expanding e-commerce platform. In paper cones, we were the number one brand in the MSAI measured channel with 41.4% market share in the first quarter up 21.4 points from the previous year our cone sales more than quadrupled year over year it was over 19 percent of our u.s paper sales in the first quarter and we expected to continue to ramp through the year we continue to lead the growth and penetration of product and convenience stores and are expanding our presence in the non-measured alternative channel including head shops and dispensaries where most of that market currently exists and where ZigZag is still underrepresented. As a reminder, cones are highly accretive to our business. Cones are a more convenient product for the adult consumer, and one cone effectively sells for four to ten times the price of an individual sheet of our regular rolling paper at retail, a significant increase to our addressable market on a per-usage basis. In Canada, we had a strong quarter of growth. Recreation marketing which is now being consolidated, contributed low single digit to our segment sales as their business continues to accelerate. Zigzag is now in dispensaries that cover roughly 75% of the Canadian market and is gaining share within that channel. E-commerce, which was non-existent last year, was a big driver of growth, once again accounting for double digits of our US paper sales during the quarter. Stoker's products saw double digit growth in the quarter, A majority of the growth was again driven by moist snuff same-store sales gains. Stoker's market share was up to 5.3%, a little over 50 basis points compared to a year ago, according to MSAI. Stoker's moist is now represented in stores representing 61.2% of industry volumes, 4.5 points above last year's level, which still leaves a long runway for further growth. Total company chewing tobacco sales saw low single-digit growth during the quarter. Stokers, too, gained an impressive 2.6 share points, with 24.7 share in the first quarter, according to MSAI. Stokers has continued to gain share every year we have owned the business. With the continued secular shift into the value category and Stokers positioning as a leading value brand, the chewing tobacco business is well-placed to provide us with a stable annuity stream of cash flow going forward. Moving to NUGEN, where we once again had a resilient quarter in a disruptive environment. In our vape distribution business, we saw strong growth and healthy gross margin improvement in the quarter despite continued competitive pressure in the market related to the PMTA process. The segment also benefited from advanced buying and anticipation of stricter shipping regulations around vaping as a result of the implementation of the PACT Act in the second quarter. Within NUX, Our white nicotine pouch product-free and wild hemp hemp vats contributed to our growth. While we continue to expect short-term volatility in the vape distribution business, we are optimistic about the optionality in the segment as the market begins to consolidate. The PACT Act is another catalyst as it will create challenges for our competitors by increasing logistical requirements to service vape customers. While this increased While this will increase costs and create short-term destruction as the industry adjusts to the new law, we believe this will accelerate the consolidation in the industry and position larger players like us well going forward. And with that, I'll turn it to Louie for a review of our first quarter financial performance. Louie? Thank you, Grant. Our performance in the first quarter was once again ahead of our plans. Turning to the segment reviews, zigzag product net sales of the quarter increased 41.8% to $41 million, with strong double-digit growth in U.S. rolling papers, MYO cigar wraps, and Canadian papers, which benefited from roughly 2 to 3 million of deliveries pushed into the first quarter of 2021. Total zigzag segment volume increased 36.9%, while price mix increased 4.9%. According to MSAI, first quarter industry volumes for U.S. rolling papers increased double digits with over half the growth driven by cones. Our volumes grew at two times the rate of the overall market, and if you strip us out, we drew three and a half times the rate of our competitors. This excludes the incremental volume growth we are seeing from the alternative and e-commerce channels. NYO cigar-wrapped industry volumes were up strong double digits in the quarter. During the quarter, we saw the segment's gross margin expand significantly by 490 basis points to 60.7%. This was the result of the financial benefits of eliminating royalty payments to Derfer, resulting in higher margins for our MYO cigar wrap product, and a creative contribution from our e-commerce business, which is currently trending above the segment average. ZigZag accounted for 15% of our segment operating income in the first quarter and continues to be our fastest-growing segment. Stokers products net sales increased 10.4% to $29.3 million in the quarter. Net sales for the MSP portfolio grew 17% and represented 63% of Stokers revenues in the quarter, up from 59% a year earlier. Total Stokers volume increased 5.1%, with price mix advancing 5.3%. Year-over-year industry volumes for MSP declined by approximately 2%, with chewing tobacco declining by approximately 4%. Stoker's shipments to retail continue to outpace the industry in the quarter, growing its MSAI share in both chewing tobacco and MST. Moving to our new gen segment, net sales increased 6% to $37.4 million. We continue to expect near-term volatility due to the PMTA process in 2021, along with the impact of the PACT Act. For the quarter, new gen gross profit increased 9.2% to $12.5 million. Segment gross margin expanded 100 basis points to 33.4%. Moving to the consolidated business. Adjusted EBITDA for the quarter was 57% to $28 million as compared to the prior year. We achieved 60% incremental margins during the quarter, reflecting the strong performance in our core segments as we leveraged our fixed cost infrastructure. In this morning's release, we also updated our 2021 guidance as follows. Net sales of $422 to $440 million. This is up from previous guidance of $412 to $432 million. This includes net sales of $103 to $109 million in the second quarter. Adjustable EBITDA for the full year is now expected to be $103 to $108 million, up from previous guidance of $99 to $105 million. For Zig-Zag, we now expect strong double-digit sales growth from double-digits previously. As a reminder, in 2020, our cigar wraps business was impacted by $5 million for manufacturing-related disruptions in the second quarter of last year, which we made up for in the fourth quarter. So the manufacturing impact was a watch for the year, but we will have an impact in comparison this upcoming quarter. We estimate that the net benefit from COVID on the overall zigzag segment last year was $7 million. For stokers, we expect high single-digit sales growth. We saw some benefit from our competitor being temporarily out of the market in the middle of the year in our loose-leaf chewing business, so we will have a tough comp for our loose-leaf business in the upcoming quarters. We estimate that the net benefit from COVID in 2020 for Stoker's was around $3 million, spread out from Key 2 to Key 4. For New Gen, we now expect a mid- to low-single-digit decline in revenue. This is up from previous guidance of mid-single-digit sales declines. This includes single-digit declines for vape distribution from previous guidance and double-digit declines offset by growth in new X. We expect the second quarter to be a challenging quarter, so we take a pragmatic view of the market in front of significantly increased logistical costs and the market impact around the PAC Act implementation. And we will also be comping against a quarter with COVID tailwinds. On COVID, we previously called out a benefit of $5 million in Q2 of last year from our competitor being offline. We also benefited from an increase in our B2C e-commerce business as more people stayed at home, especially in Q2. We estimate that the overall impact in new gen to have been $15 million from COVID in 2020, with $10 million of that in Q2. Moving to our balance sheet, we ended the quarter with $167 million of cash and $189 million of available liquidity. This puts us in an incredibly strong position to execute an active pipeline of opportunities we're currently evaluating to grow our business. With that, I'll turn the call back to Larry for closing comments. Thanks, Louis. We had a strong start to the year. Our core businesses, especially ZigZag, continue to perform exceptionally. We are optimistic about the longer-term prospects of our new-gen business as we believe that we have a competitive advantage navigating the PMTA process and the PACT Act, which are likely to be transformational events for the industry. With our business momentum and our balance sheet, we remain well positioned as a company. Our performance would not be possible without the continued efforts of our employees, and I want to personally thank them once again for their commitment and contribution to our success. I also want to take this time to thank Bobby Lavin for his contributions to the company over the last three years. Bobby has been instrumental in reshaping our balance sheet and repositioning our company for growth. We wish Bobby all the best in this next opportunity. Thank you for participating in the call today. And with that, I'd like to open up the call to questions.

Ladies and gentlemen, as a reminder, if you would like to ask a question, please press star, then the number one on your telephone keypad. Again, ladies and gentlemen, that is star one for questions. We'll pause for just a moment to compile the Q&A roster. Again, ladies and gentlemen, that is star one to ask a question. And, sir, we have no questions at this time. One moment. Okay. One moment, sir. And we do have a question from the line of Vivian Azar with Cowan. Hi, thank you. Good morning.

Hi, Vivian.

So let's start off with the zigzag segment. Really tremendous growth, far better than we were looking for. The share momentum certainly is encouraging, and it seems like you guys have incremental distribution opportunities, you know, even from here. I was wondering if you can help us think about framing APB or percent distribution. It's easier to track in measured channels, but it's a little bit more nebulous when you guys start expanding into non-measured channels. So how should we think about that? Thanks.

Yeah, so I guess in certain years, you're right, it is harder to track in the non-measured channels. Our early estimates of the alternative channel is about 40% of the market. We may have underestimated that. We still think that we are in the high single digits, low double digits share in that alternative channel. So we're still plenty of runway for us to grow there, especially kind of with the 30 share that we have in the measured channel. So I think we're still just getting started in terms of our efforts in the alternate channel.

Understood. Thanks for that. And just on the revenue accretion that you're seeing from cones, certainly that's showing up in gross margin, which is great to see. But when you said that cones can go from anywhere from a 4 to 10X, premium that strikes me as a very wide range relative to a single sheet. So what drives the variability in that premium?

Yeah, so it's really kind of the depending on the product you're switching from. So if you look kind of on our website, you know, if you look at a booklet of French orange papers, that's $2.50 for a booklet of 32. And so that drives kind of a four-times increase on the retail price for that product. But if you look at our unbleached rolling papers, which comes in a pack of 50, that's a 10-times increase to the price of the unbleached paper.

Oh, perfect. Okay, thanks for that context. Last one. housekeeping item on the zigzag segment. Can you quantify the magnitude of the revenue shift? I believe it was from Canada out of 4Q into 1Q.

Yeah, so that was just a delayed shipment from Canada. So that's about 2 to 3 million this week, Spain, shifting over from Q4 of last year to Q1 of this year.

Perfect. Okay. Moving on to the Stokers segment, I was hoping to get your perspective on some of the commentary coming out of Capitol Hill around tobacco tax harmonization, please.

John, is that a tax question?

That's right. It's a tax question.

Well, as you know, you've been following this business a long time. There's always conversations about taxes, and taxes go up at the state level all the time. The experience that we've had, that we've seen, is that there's fairly low elasticities in our markets. We do see some shifting to value after significant tax increases in states. And as you know, the Durbin bill is the first proposal. It's a very extreme. We expected to come in better than that. And even if it did, we're very well positioned. We did some back-of-the-envelope analysis that said that a After the implementation of the Durbin bill, a pack of cigarettes would be $8 and change, and a can of Stoker's would be $5 and change. So I think we're still very well positioned, even if that tax bill goes through.

Yeah, that makes sense from a cross-elasticity of demand perspective, for sure, Larry. And then if you could just expand on that thought and just speak to the implications for a federal tax on baking.

Well, there's many implications from that. One is that once the federal government taxes a product, it tends to become a partner, but it certainly legitimizes it and may relieve some of the pressure. We believe that vape consumers, even states that put on state-excised taxes, stayed with the product. consumers tend to have incorporated their products into their daily lives. And ultimately, unfortunately, the consumers will pay the tax. Almost all the taxes go through to the consumer, and the consumers will pay the tax.

Understood. Thanks very much for the call.

And your next question is from the line of Susan Anthony with B Raleigh Financial.

Nice job in the quarter. It's good to see the accelerated growth continue into the first quarter. I was wondering if maybe you could talk a little bit about the longer-term operating margin opportunity for the SOCRs and zigzag segments. I guess how much opportunity is there to continue to expand the margins there?

So we'll start out with the zigzag segment. We're not as focused on expanding the gross margins of SOCRs The zigzag segment, part of that is going to be driven by the product mix. For example, we mentioned paper cones, which is a highly accretive product for us from an addressable market perspective, but it may come at a lower gross margin than what we have for our traditional papers product, which is fine because it expands the gross profit dollar opportunity. So we're really focused on the zigzag is leveraging the gross profit dollars on the fixed cost SG&A for that segment. So don't look for too much gross margin expansion on the zigzag segment from here. On the stokers, that's a different story because MSP is a product that we manufacture in-house. So we should still keep driving incremental margins as we grow the volumes of that business.

Okay, great. That's really helpful. And then maybe if you could talk a little bit about the NUX brands and the response you're seeing from the consumer. It seems like With the better guidance there in the new gen category, it looks like it's doing a bit better than expected?

Yeah, so part of that is being driven by the PAC-DAC implementation that we mentioned earlier. So we did see some pull forward in sales as our customers kind of pre-bought in advance of the higher shipping costs as a result of the PAC-DAC. There is going to be some short-term volatility, but we are seeing a big opportunity for us as the market consolidates with our competitors going away. So I think that's part of what you're seeing in the strength on the new gen side of the business.

Okay, great. And then I guess just last one really quick, if maybe you can give us an update on what you're seeing on the acquisition front, where you're seeing the most opportunity in terms of by segment and kind of where you're really focused on.

Sure. So we just did this investment in Doclight, which we are very excited about. The focus there is really we want to build a house of brands in the cannabis space, so that complements our investment in doses. We're looking to do a few more of these, not too many, and we kind of view these as a way of dipping our toes in the water and eventually acquiring these brands into part of the consolidated company. We have mentioned that we are active in the cigar space. It is a $2.5 billion market opportunity for us. So we are evaluating opportunities from an acquisition perspective there. So look for us to do something there in the short to medium term. We are also focused on expanding our product offerings. So we are touching 210,000 retail outlets in North America. There's a lot of other products that go into these stores, which are mostly C-stores, that we can drive through the same sales infrastructure that we're currently using. So we are, you know, looking at what we would call a fourth light to the school. So there's various opportunities that we are pursuing.

Okay, great. I guess just one follow-up, I guess, for the investment such as DocLight, you know, how are you guys thinking in terms of the timeframe there for you know, eventually making a full investment in the company.

So Docklight comes with an option of investing another slug into the business. You know, eventually... the way we're approaching the cannabis segment is, you know, we think that the market today is going to be significantly different than the market, you know, five years from now. So making investments in small investments in companies like Dosis and Doclight with an opportunity to invest in another chunk and eventually fold them into our company, the approach that we're taking there.

Great. Okay. Thanks so much. Good luck the rest of the year.

And your next question is from the line of Eric DeLaurier with Craig Hallam.

All right, great. Thanks for the question, and congrats on another really strong quarter here. Focusing on the zigzag business, obviously really strong growth there as well, and just trying to parse through that measure versus the alternative channel opportunity. How should we think about that opportunity in terms of papers versus wraps? Any major difference in either the current distribution or sort of market share potential that you guys see for papers versus wraps in that alternative channel? Yeah, so the alternative channel is really mostly a papers opportunity. So part of that is you need a tobacco license to sell our wraps product. And so that sits mostly in our in our measured channel still. So really the opportunity in terms of expanding our presence, the alternative channel to more of a papers that that's true for both the US and Canada. OK, and then I'm assuming that it's sort of a higher mix of cones in the alternative channel than in the measured channel, but any sort of ability to kind of quantify the opportunity for cones versus booklets in that alternative channel? Yeah, so it is a heavier mix of cones in the alternative channel versus papers. And we think that the cones market is as large as the paper booklets market, and it is more represented in the alternative channel today than it is in the convenience store channel. Really, we're driving the growth in the convenience store channel right now. Okay, great. Yeah, that's very encouraging, Kirby, upside the gross profit there. I guess switching gears just a little bit here, focusing on M&A. So you've talked about M&A in the past in terms of sort of filling gaps in not only your product portfolio but the infrastructure as well. As it relates to the cannabis M&A opportunity, you know, it seems like you guys are doing a really good job filling in the product side with Dosis, Wild Hemp, and Docklight. But could you touch on any of the infrastructure side of those acquisitions and maybe help us understand what product or infrastructure gaps you might still be targeting for M&A in the cannabis sector? Yeah, so we kind of view ourselves as a branded consumer products company, right? So cannabis is a large and growing market that we are looking to extend our exposure in. And obviously with Dose, it's one of the strongest brands on the vape side and now on the gummy side in California. And Bob Marley, which is one of the most iconic brands in the cannabis space, we have added to our portfolio of brands that complement ZigZag well. So we are looking to extend our exposure there further. And, you know, our focus is on brands, but we're also looking across the supply chain to see if there are opportunities out there to help extend the reach of our brands further. Okay, great. That's helpful. Yeah, thanks again, and congrats again on the strong quarter.

Your next question is from the line of Haley Holden.

Thanks for taking the call. I just had two for you. Following up on the M&A theme, I was wondering if there have been any changes with some of either the tax noise out of Washington or the regulatory noise out of the FDA in terms of your ability to underwrite potential M&A transactions or sellers coming out of the woodwork.

I haven't really seen much changes yet. I mean, obviously, you know, there's still a lot of uncertainty in terms of what's happening on the tax rate. So I don't think we have really seen much in terms of any activity changes or results to potential changes on the tax code. Okay.

And then my second question was, I think you mentioned in the script the potential for higher freight costs in the second quarter. And I was wondering if you could just give a little more color on that.

Yeah, so a lot of that is being driven by the past act implementation. So we're forecasting a decent increase in terms of kind of our ability to fulfill orders. So some of that is going to be passed on to the consumer. But there's also a big opportunity for us from a market share perspective as some of our competitors are going away this upcoming quarter. So we're looking to invest to grow our market share next quarter, or this coming quarter.

Great. Thank you very much.

And your next question is from the line of Greg Pendy with Sedoti.

Hi, guys. Thanks for taking my questions. Just real quick, on the FDA warning letters, are those predominantly open tank players, or is that just a mix of both? type of players? The bulk of them are the open tank players. A lot of mostly liquids. Okay, great. How should we be thinking about this year? I believe you took price increases in Stokers in May and July, if I'm not mistaken. Is there an expectation for some price increases coming through this year around those times? The price increases in Moist come in fairly regularly. So, yeah, you'd expect the schedule to be somewhat similar to last year's. Okay. And then just one final question. Can you just kind of just in general, how should we be thinking about in ZigZag, the e-commerce channel, how big is that right now, or is it just too small to kind of quantify at this point? So within our U.S. papers business, it's double digits of our sales. So we expect that to continue to ramp for us through the year. Okay, great. Thanks.

And, sir, there are no further questions. Mr. Rifalmina, do you have any final remarks?

We'll turn the call over to Larry. Well, thank you, everybody, for joining the call. We look forward to seeing you at the end of next quarter. And stay safe and see you in July. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.