Turning Point Brands, Inc.

Good morning and welcome to the Turning Point Brands first quarter 2022 earnings conference call. All participants will be in a listen-only mode. All 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 that this event is being recorded. I would now like to turn the conference over to Louis Reformina, Chief Financial Officer. Please go ahead.

Thank you, Operator. Good morning, everyone. This is Louis Reformina, Chief Financial Officer. Joining me are Turning Point Brands President and CEO Yavor Efremov and Graham Purdy, Chief Operating Officer. 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. There is also a presentation we will be referencing on the call available on the site. On that presentation, if you turn to slide two, our disclaimer, during this call, we will discuss our consolidated and segment operating results and provide a perspective on our progress against our strategic plan. As is customary, 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 SEC. On the call today, we will reference certain non-GAAP financial measures These measures and reconciliation of the gap 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 our CEO, Yavor Efremov. Thank you, Louis.

Good morning, everyone, and thank you for joining our call. We had a strong start to the year with our first quarter results in line to slightly better than our expectations. ZigZag continued its strong growth trajectory with another quarter of double-digit growth led by our U.S. papers business, building on its market share gains in the measured channel. In addition, we're showing good progress in our alternative channel efforts as we benefit from increased sales force focus into the channel and the secular growth in the industry. Stalker's MSP also saw double-digit growth during the quarter. While inflation is pressuring the consumer wallet, Solvers was well positioned with its value proposition to capture share as consumers traded down during the quarter. Meanwhile, NewGen navigated an expected decline in sales resulting from the PACT Act and the regulatory environment. Our vape distribution business remained profitable despite these challenges. I'm very proud of the fact that we completed the scope of both the ERP and the CRM system within the quarter and did so on plan and on budget. While this is only the first step of a long journey, I am encouraged by the fact that we did all of that that needed to be done while still delivering a strong quarter. We did not cut corners and had full engagement in the process top to bottom. I believe this says a lot about the organization and its potential. On April 14th, the FDA obtained regulatory oversight over non-tobacco nicotine products. As a result, these products are now subject to the same regulatory regime as tobacco-derived products. Pre-market filings for non-tobacco nicotine products must be submitted by May 14th. Products subject to a timely filing may remain on the market until July 13th unless they receive a negative action. After July 13th, these products become subject to enforcement. We view FDA oversight as a critical component of effective regulation of the entire industry. And while it may cause some short-term disruption around upcoming deadlines, we view this as a long-term positive to level the playing field and continue to enhance our position in the industry. With regard to our product portfolio, We aim to file new applications for a number of non-tobacco nicotine offerings, including our free nicotine pouch products, and we are evaluating spending up to $10 million on PMTA applications throughout the year with a heavy focus on modern oral. On capital allocation, we continue to buy back shares during the quarter after receiving increased authorization from our board. We continue to be committed to not growing our cash balance from here as we aim to use our cash flow to invest in our organic growth. Practically all remaining cash flow will be directed towards buybacks so long as the shares remain priced attractively. On the M&A front, as stated before, that is not our new term focus. However, to reiterate from the previous call, Our intent is to be patient and do deals that leverage our brand and distribution expertise and will be value-creative to shareholders. Any large-scale transaction we pursue will be synergistic and thus leverage an existing asset, including our distribution network, to drive shareholder value. We may also pursue smaller stocking acquisitions that deliver a capability to service our existing business that we prefer to acquire rather than build organically. We recently announced the hiring of a new CMO, Tamma Frein, who brings extensive consumer products industry experience and we're excited about what she and our marketing team can do to further build our brand. In addition, we have also brought on a chief information officer to oversee our technology systems including our ERP implementation, and a chief people officer to support our organizational infrastructure. We have revamped our organizational structure to improve accountability and more clearly define functional responsibilities and the reporting structure within the organization. We have also realigned our segment reporting to better reflect the results of our vape business. NuGen in the past was a combination of a profitable vape distribution business and our NuX product development platform. Effectively, we have streamlined and integrated the non-vape part of NuX into the rest of the organization from an operational and financial reporting standpoint. NuGen results are now a clean representation of 100% of our vape organization as if it were a standalone entity. With that, let me turn the call back to Lloyd to go through our results.

Thank you, Yavor. Starting with our consolidated results on slide four, Q1 sales were down 6.3% to $100.9 million, with strong zigzag and stoker's growth, offset by a double-digit decline in new gen, which was impacted by the regulatory environment, including the PAC-DAC. Adjusted gross margin increased 180 basis points, driven by improvement in Stoker's gross margin, along with a mixed benefit from increase in sales in our higher-margin Zigzag and Stoker segments, and decline in lower-margin new-gen sales. Adjusted EBITDA was down 2.7 million year-over-year, with a decrease coming from the expected decline in our base distribution business. Now, turning into the segment performance, slide 5 for Zigzag products. Sales grew 11.4% year-over-year to $45.7 million, with 7.1% from volume and 4.3% from price mix. Wraps revenue was down 3% year-over-year due to an industry decline in the HTL wraps category, offset by growth in natural leaf and hemp wraps. We believe the trade was building up inventory in the first half of last year in HTL wraps and is now working its inventory to more normalized levels. Partially offsetting this was our ramps of the zigzag natural leaf and hemp wraps during the quarter, which collectively accounted for double-digit percentage of our wrap sales during the quarter. As a reminder, in our second quarter, we will have a tough comparable as last year's second quarter benefited from 2 million of pull-forward of sales into the quarter. Our U.S. papers and e-commerce business was up 41% year-over-year, driven by growth in e-commerce and paper co-sales, as well as a planned 2 million inventory load with certain customers. E-commerce was up 2.6 times and now represents 21% of the sub-segment with strong growth expected the rest of the year. Our B2B e-commerce business, targeting the alternative channel, led the growth and accounted for more than half of our e-commerce sales. Sales of Kohn's products was up 78%, including over 4.4 times in our e-commerce channel, and is now 25% of the sub-segment. ZigZag remains the number one premium and overall paper brand in the MSAI measured market. with 33.3% share, which is up 30 basis points year-over-year. ZigZag was the number two brand in the paper cones category in the MSAI measured market, with 34.2% share. Cones continues to remain a large opportunity, with only one-third of stores receiving paper products also receiving cones during the quarter in the measured market. Overall, the paper category saw a decline in MSA, down 3.5% during the quarter. Canada was down 13% during the quarter. This expected decline was primarily due to the timing of orders from our third-party distributor last year when we delivered half of our sales for the full year in Q1, creating a tough comp. TPB Canada, which is the old recreational marketing business, continued to perform well and grew double digits organically. The cigars and other subcategories grew 17%. We grew up in our cigars business. In the addition of 0.2 million of wild hemp sales previously recognized in UGEN, We introduced our rough cut natural leaf cigars during the quarter and expect a steady build this year. Gross margins for the segment declined 300 basis points during the quarter. The consolidation of TPB Canada was the biggest driver of decline, given the lower margins from the DBW acquisition last year. Margins would have been down 80 basis points, excluding TPB Canada in both periods. The decline driven by higher growth and lower margin products like our paper cones. The operating margin decline for the quarter was due to the gross margin decline. the impact from the DBW acquisition as part of TPB Canada, and the reallocation of segment costs, in particular personnel from Newex now dedicated to ZigZag marketing. Increased sales and marketing costs and increased shipping costs also led to this decline. We were also excited by the continued push of our marketing team to strengthen the ZigZag brand during the quarter. Following the launch of ZigZag Studio late last year, we recently launched a partnership with luxury fashion line Amiri for its Spring 2022 collection, which is now available for purchase in stores like Saks and Bergdorf Bidman. Zigzag accounted for 57% of our segment operating income in the quarter and continues to be our fastest growing segment. The fundamental long-term drivers for the segment remain intact as cannabis continues to gain mainstream acceptance and new states come on board on legal recreational sales, including New Jersey last week. Turning to slide six, Soaker's Products. Sales increased 8.4% to $31.7 million in the quarter, with 0.3% for volume and 8.1% for price mix. Net sales for the MSP portfolio grew 11% and represented 65% of stockist revenue in the quarter, up from 63% a year earlier. Category volume was down 5.6% while we were up to 0.9% as our share grew 40 basis points to 5.7% during the quarter, according to MSAI. Our share in store selling was up 30 basis points to 9.0%, which Stoker's now in stores representing 63% of industry volume, which still provides a long runway for our growth. Chewing tobacco sales declined 3.6% from the previous year. Category volume was down 5.1% during the quarter, according to MSAI. Stoker's Chew was the number one chewing brand in the quarter, gaining 100 basis points of share to 25.7%, according to MSAI. Despite a softening in the industry demand within the tobacco industry in general during the quarter, Stokers performed well as its value proposition products resonated well with consumers, especially in the current inflationary environment. Segment gross margins expanded by 150 basis points to 55.8% during the quarter, driven by price and incremental margin from our higher MST volume. Operating margin increased 70 basis points with a higher gross margin from soaker sales partially offset by the higher sales and marketing costs and increased shipping costs. Turning to slide seven, new gen products. We continue to manage through a disruptive environment with sales down 37% from the previous year to 23.59. Our vape distribution business continues to be disrupted by the regulatory environment, including the implementation of the FACT Act late last year. Adjusted gross margins were down 40 basis points year over year. Adjusted operating income was down $1.3 million due to the lower sales and higher freight costs offset by lower variable S&A and reallocation of shared costs into the corporate segment, as mentioned earlier. New general results this quarter are now a cleaner representation of our vape business, which remained profitable despite the challenging environment. Encouragingly, our B2B business had its strongest revenue month of the quarter in March, and our B2C business continues to build its last mile distribution reach. We are still awaiting progress in the FDA and our PMCA applications and continue to adapt our business based on the changing dynamics in the industry. Ultimately, we still believe that all the short-term challenges present an opportunity for us in the long term, given our size and our ability to navigate the regulatory environment. Moving to slide eight. We entered the court with over $126 million of cash in the balance sheet and $147 million of available liquidity, providing us with flexibility on capital deployment. We repurchased 10.6 million of shares during the quarter. As mentioned in the press release, we are maintaining our previous guidance as communicating the Q4 earnings call. In addition, as Yalvar mentioned, we are also projecting up to 10 million of PMT spend, which includes filing some additional products, including our pre-nicotine pouch. With regards to CAPEX, we are still reviewing projects that we believe will drive value to the organization, which include the ERP upgrades. We do expect CapEx to be higher this year and hope to provide a firmer update once we have pricing on our ERP and CRM projects later this year. We are evaluating spending up to $20 million for the entire year, excluding the ERP projects, with the increase attributable to $9 million from a manufacturing automation project that we started last year and $8 million from a potential warehouse consolidation and automation project that we are evaluating. Thank you for participating in the call today. And with that, I would like to open the call for questions.

Thank you. If you would like to ask a question during this time, simply press the star key followed by the number one on your telephone keypad. If you would like to withdraw your question, press star one once again. And we'll pause for just a moment to compile the Q&A roster. And we will take our first question from Eric Collorier with Craig Howland Capital Group.

Great. Thank you for taking my questions, and you've got some solid quarter here. I was just wondering if you could just expand a bit more on the inflation costs that you guys are seeing. I see that you called out some higher freight costs. Obviously, you guys do have some sizable margins and ability to absorb that, but just if you could give us a sense of what you're seeing from an inflation perspective and your ability to pass that on, that would be great. Thank you.

Yeah, sure. I mean, shipping is one of our larger variable costs, especially in our new gen segment. So a lot of the shipping freight increases for the quarter for new gen was related to the PACS Act implementation. So our shipping costs, the percentage sales within that segment was up over 300 basis points year over year. In what I would call our Zig Zags as products traditional channel, our shipping costs were up a little bit, but not to the extent that we saw in our new gen segment.

And are you guys seeing any other, um, you know, material signs of, uh, of inflation at this point, whether it be, you know, packaging or labor or, um, um, anything like that, just any other sort of signs of, um, inflation that you may or may not be seeing would be helpful. Thank you.

Yeah, we're not immune to the labor pressure and, uh, that everyone else is feeling. So we are, you know, kind of seeing that we started seeing that already last year. Um, and yet we have our normal merit increase for employees this year. And so we're seeing it like everyone else is.

Okay. All right. That certainly makes sense. And then just last for me here, could you just kind of help us understand the impact that you expect to see from adding Clipper distribution starting in the second half here? I mean, I know the way I kind of see it, sort of adding this penetration into the alternative channel and a bit of revenue synergies the other way around as well. Maybe just kind of help us understand whether qualitatively or quantitatively sort of, you know, what you're expecting in the second half here with Clipper. Thank you.

Sure. Yeah, I mean, we mentioned that, you know, Clipper in the U.S. became about, in lighter markets, about $500 million from a manufacturer revenue standpoint. They had about 3% share in the U.S., and we're taking that over in the second half of this year. There's going to be a transition period as there are distributors that we are transitioning from. So we're a little bit cautious in terms of how we're protecting it. But long term, it is a large opportunity for us given the size of the market and given Clipper's success in other markets where they've gained number one share.

Okay, great. Thank you very much. Appreciate it.

We will take our next question from Vivian Azer with Cowen.

Hi, thank you. Good morning. Louis, I was hoping to follow up first off with the comment that you made around softening the tobacco demand through the quarter. Any incremental color you can offer on that? You know, clearly we can see it in the scanner data. Higher gas prices are problematic for the category. But how is that materializing in terms of changes in consumer behavior? Thanks.

Sure. So this is the hour. Let me take this. One area where we're different from most CPG companies is our consumer shows up immediately after visiting the gas pump. And there was a significant price shock on the consumer, which we saw late in the quarter, late in Q1, and we've seen reverberate a bit into April. Hopefully that's a temporary appearance that gets adjusted. But the net result is you have a consumer who is now spending a lot more at the gas pump, which by definition means there's a lot less left to spend when they hit the convenience store. And what we've seen from a behavior perspective is people shifting One, towards the cheaper price points, which benefits us. Obviously, we are the value brand, and you saw that we're gaining share. We have continued to gain share throughout the quarter. That has continued as far as we can tell into April. So we're happy with gaining share. At the same time, the consumer has less money to spend. So you're seeing some trading away from tops and more towards cans, because the can is obviously a lower price point, even though it's more expensive and you know, on a weight basis. I'm not sure if that's helpful, but kind of the pressure, we're not, at this point, it's too early to tell. We're happy where we are. We're continuing to take measures to make sure that we continue to gain share, which we've done last quarter. We're doing it today. But we'll see which way the quarter goes.

Yeah, and I think, you know, Vivian, as you know, I mean, as you know, the category is generally inelastic. but it's not immune to short-term temporary shocks.

Yeah, which dovetails perfectly into the follow-up, which if our math is correct, you guys realized a very healthy 8.1 point benefit from price mix realization in the stoker segment in the quarter. Obviously, pricing where you guys are not the price leader, but pricing from a category perspective has been incredibly healthy. So, you know, all else equal, not talking about future price increases, but Louis, maybe just remind us for the price increases that have already been implemented in the marketplace, like how does that flow through the next three quarters of the year? When do we start anniversarying the last of those price increases such that, you know, absent any incremental price increases, when would you expect that to normalize? Very healthy right now.

Yeah, I mean, generally, the industry has been taking, in the past two and in the last few years, the three price increases a year. And in the last year, we just took one in February, and the last one we took last year was in June and October.

Got it. Perfect.

Thank you so much. And we will take our next question from Susan Anderson with B. Reilly.

Hi, good morning. Alec Lang on for Susan. On Zigzag, just looking at longer term, say the next five years, what do you think presents the largest opportunity of growth for the brand?

Yeah, so for Zigzag specifically, obviously Clipper is a large opportunity for us on a brand that we think is phenomenal and has had success internationally. So that is, for a segment, one of the big ones that I think can drive a decent amount of growth for the next couple of years. On top of that, we are continuing to introduce new products into the market. So cigars is a big opportunity for us. It's a very consolidated market, so it won't be easy, but we started with the introduction of our rough-cut natural leaf cigar product in Q1, which we are excited about. On top of that, there's other new product launches. Natural leaf continues to ramp up. Hemp wrap continues to ramp up. We're going to launch other products like palm leaf sometime later this year or into next year. On top of that, we still feel we are under-penetrated in the alternative channel. As I mentioned, B2B e-commerce led our growth in our zigzag e-commerce businesses here, and a lot of that was driven by our alternative channel sales effort. We're continuing to build our alternative channel sales force, and we expect that to pay dividends for us over the next couple of years.

And just to reiterate that last point, we are deploying significant resources into the alternative channel, both in the form of hiring sales personnel as well as meaningful marketing efforts. And we're seeing great traction, great returns so far, so we'll keep doing that. I'll just say the obvious is legalization takes more and more states and makes it, you know, frequent. get to federal legalization. Those are all trends we're going to ride for a long time. And in terms of the alternative channel, we're in the very early innings in terms of growth. So we have a long, long, long path of hopefully consistent and strong growth.

That's what we're seeing right now, and I don't have any reason to believe it's going to be different.

Thanks. And I guess just to follow up on that, I mean, ZigZag, I feel like, is probably one of the most recognized moking related brands in the U.S., and you just had that partnership with Amiri. Thoughts on maybe licensing out the brand image or even expanding your apparel and collectible collections going forward?

Look, we have a fantastic team that's handling marketing.

We just brought some of our infrastructure on it. This is the reason we're investing heavily behind the brand. We did say on Q1 that we will continue to support marketing. I think they've done a phenomenal job in developing relationships, partnerships, collaborations. You should expect to continue to see that, and we'll do a lot of it because it's highly effective. The fact that our competitors are complementing it when we speak with them speaks for itself. That being said, we're highly unlikely to start licensing our brand.

That's just not currently on the plate.

If you look at our website today, we have a limited edition $1,000 box, a pretty hefty offering that we just launched and is almost sold out already. I think what they're doing in terms of product development and partnerships and general marketing has been beneficial for our brand.

As a reminder, if you'd like to ask a question, hit a star one on your telephone keypad, and we will take our next question from Gaurav Jain with Barclays.

Hi, good morning. So a few questions. So number one is, you know, on the M&A front, you know, we had an extensive discussion last quarter on, you know, how you are thinking about M&A. But, Yavor, if you had any further thoughts, you know, what have you looked at, anything interesting, and which – Which categories you might be looking at here?

So, look, the quarter was entirely cut down and executed on the business. We have a lot on our plate. And as I mentioned both on the previous call and on this call, we view M&A as opportunistic, and it's going to take time to actually find the right deal. I would reiterate what we've been saying. The right deal has to be synergistic. We have to have an angle for it. Whether that's our distribution, which is obviously the most obvious angle, or some other asset that is unique to us that we bring to the table, the deal is going to be synergistic. Here is full stop. Again, the only other qualifier I would add is we may do small stockings to address things that we'd rather buy than build, but those are going to be small.

Okay, thank you. And second is on this 10 million PMTA costs, which I don't recall were specified earlier, and it is a decent amount of money. So could you just help us understand where you would be putting those PMTAs? Because I would have thought that you would be able to use the PMTAs that you filed last time largely to file the new PMTAs. So maybe you're going into some new products. So can you just help us understand? why we have this $10 million cost.

Yep. So let me start by just describing what the PMTA is meant to cover. The focus of the PMTA filings is going to be moderate oral, to be clear. We have very little vape in it, and the vape part is going to be in partnership with others. So essentially we'll be supporting somebody else's PMTA or we'll have an arrangement with somebody else where we're spending very little money but hopefully getting the benefit of it. The part where we have spent the lion's share of the $10 million is our own proprietary products, which are going to be strictly modern oral. One of them is free, obviously. And we have another product which we have not discussed. I'd like to hold off on discussing it, but it is modern oral. It is different. We think it's very different. We like it a lot. We'll see how it works. But we're very, very, very excited about it. And it's That's what the PMTA is meant to cover. In terms of when we discussed it, now you are correct. We did not discuss it on the previous earnings call. We were still figuring out the exact timing. And to be honest, our preference would have been to file the PMTAs later in the year after we've had more time to test the market, see reactions, get feedback. And all of that got accelerated by the FDA and Congress. And that's just the reality of it. In terms of overall spend, I can tell you that we had about $9 million in the budget. It went to $10 million as a result of the acceleration. But we've been working on the PMTAs for quite some time, and this is not something you can do in a rush, which is why it would be interesting to see what people file, because we've been working on our PMTAs for months and months.

So, you know, I wouldn't say anything about it.

Go ahead.

So, you know, I was just going to ask that if you're putting that much money behind modern oral PMTAs, then could you also then share what your learnings have been from free so far in terms of like how much have you sold and what is the velocity, how many places are distributed? I mean, I can see it online. but how many stores distribute, and how do you compare velocities of, let's say, free versus broker? Or some numbers, if you could share, that would be quite helpful for us.

Hi, Gaurav. This is Graham here. You know, sort of consistent with our philosophy the last year and a half or so, we've taken a very measured approach to approaching the marketplace with the products in terms of store identification and Salesforce allocation of time. To date, we're in roughly 15,000 stores. The success of the product in those stores is incredibly encouraging. I'm not going to go into specific numbers. I would just tell you that we're starting to cleave off some nice market share gains in those stores.

And, Gaurav, the one thing I would add is just from a reorder perspective, in comparison to other launches we've done, this has the highest reorders that we've ever seen. So we thought that's encouraging. And just to be clear, I think our product is the only one that allows full step down from a higher level to a lower level. So if you're looking to quit, we're walking you all the way from high to low. And that makes us very unique in the market.

To accomplish the same result with a competing product, you have to be walking around with a mouthful of pouches, which is not all that attractive.

Okay. Well, thanks a lot.

And there are no further questions at this time. Yavor, I will turn the call back over to you.

I would like to thank all of you. Obviously, we had a very, very good quarter. I'd like to, again, thank everybody for their patience. We are obviously investing into the company. We're very optimistic. I've been here for a few months now, and I can tell you that I'm more optimistic now than I've been in the last few months. The more I learn about this company's people and its potential, the happier I am that I am here, and the more I look forward to what we can do together. We look forward to the next earnings call and talking to you guys. Thank you all.

This concludes today's conference call. You may now disconnect.