Turning Point Brands, Inc.

Good morning and welcome to the Turning Point Brands' fourth 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. Good morning, everyone. This is Louis Reformina, Chief Financial Officer. Joining me are Turning Point Brands President and CEO, Graham Purdy, and Chief Revenue Officer, Summer Freed. This morning, we issued a news release covering our fourth 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. During this call, we will discuss our consolidated and segmented operating results and provide our perspective on the operating environment and our progress against a 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 Securities and Exchange Commission. 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, Graham Purdy.

Thanks, Louis. Good morning, everyone, and thank you for joining our call. Last quarter was my first as CEO of Turning Point, and I discussed my excitement about our team and our ability to build a world-class CPG company for the benefit of our stakeholders, employees, and valued customers. As I mentioned on our last call, my main priority is to focus on internal execution across all areas of our business to best position Turning Point for profitable long-term growth to drive shareholder value. Since my appointment to CEO, the team has been focused on evaluating all aspects of our business, from our distribution and channel strategies to our product portfolio and go-to-market plans, and improving our systems and logistics capabilities to become more efficient. There's a lot on our plate, but it's all designed to help build a stronger foundation for long-term growth The main components of our strategy are, number one, to expand our market penetration and competitive share, especially within the alternative panel. That's the power of our brands and differentiated product portfolio.

Number two, to leverage our unique distribution and marketing performance to strengthen our customer and consumer relationships by providing value-added products across panels and platforms.

Number three, Invest in high-return operational and productivity initiatives throughout the organization to drive efficiencies and better manage what's fully in our control. And number four, to attract, train, and build a world-class team that is aligned and incentivized to drive shareholder value. Number five, to adopt an owner's mindset throughout the organization to empower our team to attack their best opportunities and operating like true owners with required speed and focus. The team is focused and energized behind the strategy, and I'm excited by the compelling opportunity to build long-term shareholder value. Before Louis, Summer, and I go into the recent quarter guidance, let me discuss some of the progress we've made and some of our operational priorities going forward. First, as we discussed during our last call, ZigZag remains the number one rolling paper brand in North America, and we're beginning to see early fruits of our labor to further penetrate the alternative channel. We firmly believe that brands with scale are increasingly important, and our enhanced portfolio across categories, from traditional papers to combs, wraps, accessories, including clipper, allows us to offer our retail customers a more complete product assortment to address their needs across a variety of adjacent categories in the store. Our portfolio of Zig Zag products continues to benefit from cannabis legalization, and the underlying trends remain strong. Flowers continues to lead the way across the country, and while revenue growth has slowed for cannabis operators, Much of the moderation relates to significant flower price compression, which is masking continued growth in consumer demand and unit volumes, which should benefit the zigzag portfolio over time. Regarding the current environment, inflation and rising interest rates continues to pressure our end consumer and the entire value chain. This is causing our wholesale customers to evaluate inventory levels. This has made projecting quarterly results more challenging, particularly at the segment and skew level in recent quarters. 2022 was a challenging year for many CPG companies given the inflationary pressures and economic uncertainty, and we certainly weren't immune. However, our fourth quarter was in line with our expectations on both top and bottom line. While inflation seems to be evading some areas, for example, gas prices have eased since October, our end consumers are still feeling economic pressure, and our wholesale customers are carefully monitoring inventory levels in response to lower in-store traffic and pressure on working capital. This theme is consistent with what we are seeing across other CPG categories. On a segment basis, ZigZag saw growth in the quarter despite the previously disclosed headwind of a pull forward from promotional activities in Q3. Stokers delivered another solid quarter highlighted by double-digit growth in MST as we saw strong share gains in both MST and loose-leaf categories. NewGen's year-over-year decline moderated from previous quarters and remained profitable during the fourth quarter, despite the continued challenging regulatory environment. As I committed back in October, we have taken a critical first step with our NewGen business by announcing the creation of Creative Distribution Solutions, a newly formed and wholly owned unrestricted TPB subsidiary that will house our NewGen assets and certain minority investments overseen by an independent board. We believe this reorganization best positions the business to navigate the current regulatory environment, adapt to future marketplace changes, and pursue further value-maximizing opportunities as they arise. All of our stakeholders will continue to participate in the asset's potential upside optionality while providing us more flexibility to maximize value as the regulatory environment and marketplace continue to evolve. Looking ahead, we're currently projecting full-year 2023 adjusted EBITDA of $88 to $94 million. but I wanted to give you some additional context. At the midpoint, we expect first quarter 2023 EBITDA to be down year over year, but to show year over year stability for the balance of the year. Here's what's going on in the first quarter. For one thing, we think the macro environment, principally inflation, started impacting our consumers in earnest in the second quarter of 2022. Last year's first quarter was generally stronger than what we saw as the year progressed. Second, As a result of the rising industry environment, which has increased the carrying cost of inventory, we've seen the reduction of inventory by some of our large customers, and others have communicated they plan to do the same through the first several months of the year. Lastly, when we launch a new product like Clipper, there's typically an initial surge in sales as we load the channel. We benefited from that situation in the second half of 2022. That initial load-in is typically followed by a pause as that inventory gets absorbed. This was coupled with inventory remaining from previous distributors and retailers from the transition. We expect to see this dynamic play out early in the year, followed by a rebound and steadier rate of growth moving forward. Despite these temporary inventory factors impacting our expectations for the first quarter, when we look through these transitory drivers, we are seeing encouraging trends with consumer takeaway that gives us confidence in our growth prospects. With that, let me hand the call over to Summer to walk through progress and results of some of our specific go-to-market initiatives.

Thank you, Graham. Starting with our increased focus on the alternative channel, which we previously defined as direct-to-consumer storefronts like Amazon, brick-and-mortar head shops, smoke shops, and dispensaries, we see continued store growth and consumer traffic as legalization spreads throughout the country. not only with legal dispensaries, but also with head shops and smoke shops that also benefit from new state program launches. Approximately half of the country's population now live in approved legal recreational states. This is a meaningful jump from around 20% five years ago, and we expect continued state expansion over time. Our e-commerce and direct B2B alternative business, which effectively captures some of this new demand and serves as a proxy to measure our alternative sales efforts, grew 26% in the quarter. For this year, we will leverage our progress to further exploit this opportunity. We have a clear game plan for this market, and some highlights include enhancing our in-store presence, accelerating product innovation, and focusing our distribution efforts to ensure better sales coverage to increase penetration of new doors. I believe this approach will best leverage our ongoing strategy to invest in ZigZag to solidify the brand as a leading must-carry item. While we're still in the early innings of executing our alternative strategy, I'm encouraged by these results and the progress we've made on many initiatives since we last spoke in October. We believe that improving our presence in this faster-growing channel represents a tremendous opportunity as we estimate it currently represents half of the paper's and ancillary accessories market. Meanwhile, Clipper Lighters is continuing its expansion. Over the first five months of the launch, our Salesforce sold Clipper Lighters into approximately 25,000 new retail accounts, making it one of the most successful initial launches in our company's history. With less than 3% share in a roughly $500 million market, Clipper has plenty of runway for growth as we follow a playbook that has delivered 20 to 50% market share in other developed markets around the world. Moving on to the Stoker segment, Stoker's had a strong quarter and year, gaining market share and points of distribution. We were also able to continue to take pricing during the year. We firmly believe we're still in the middle innings of the brand evolution, driven by Stoker's positioning as a high-quality MST product priced for the value consumer. Our Stoker's business is also benefiting from the secular trend of consumer trade-downs. The inflationary backdrop has likely helped to accelerate market share growth and drive new consumers to the brand. Once consumers experience stokers, we generally keep them as the brand consistently delivers on its brand promise to provide premium satisfaction with significant savings. On the product innovation front with Smokeless, our recent launch in the modern oral category with our free brand is allowing us to participate in the growing $1 billion white pouch category. In rapidly expanding markets, such as modern oral, We believe we don't need to be the biggest or send the most to generate significant value for shareholders, as we've proven with Stoker's MST. We are taking a highly disciplined approach towards growth and are encouraged by early consumer feedback. We are fine-tuning our strategy to profitably scale into this segment. In summary, we are hyper-focused on maximizing value of our world-class brands and extensive distribution capabilities. Let me now turn the call back over to Louie to go through our results.

Thank you, Summer. Starting with our consolidated quarterly results. Q4 sales were down 1.8%, 103.4 million, impacted by new gen, which had an 11% year-over-year decline. Our core product, ZigZag and Stokers, grew 0.9%, 2.6% respectively, or 1.6% combined. Adjusted gross margin was flat at 47.9%. Adjusted EBITDA was down 0.7 million year-over-year, with a decrease coming from the decline in our vape distribution business, going into segment performance. Zigzag sales increased 0.9% year-over-year to $52.1 million, with 0.8% from volume and 0.1% from price and mix, despite the negative impact of a pull forward in sales since the previous quarter. Wraps revenue was down 9% year-over-year, as we compared against the period when we launched Natural Leaf Wraps and Zigzag Hemp Wraps. Our U.S. paper in e-commerce business was down 13% year over year, driven by a paper booklet decline, partially from the pull forward into Q3, and some of the trade inventory adjustments that Graham mentioned earlier. This was offset by double-digit growth in e-commerce. Canada was up 22% during the quarter, with solid growth aided by the launch of Clipper. The cigars and other smoking accessories subcategory grew dramatically off a low base due to the Salesforce efforts behind Clipper. Gross margins declined 180 basis points during the quarter, driven primarily by the Clipper launch and higher growth in lower-margin products like paper cones. Operating margins declined 430 basis points for the quarter due to the gross margin decline, variable SG&A costs from increased e-commerce sales, increased TPB Canada SG&A, and the reallocation of segment costs. The fundamental long-term drivers for the segment remain intact as cannabis legalization continues to drive growth in the all-channel, and Clipper penetration provides further tailwinds. Stoker's product net sales increased 2.6% to $32.0 million in the quarter with a 6.1% volume decline and 8.7% price mix increase. Net sales for the MST portfolio grew 13%. Stoker's volume was up 4.3% despite category volume down 8.9%, with share growth accelerating 80 basis points year-over-year to 6.6% during the quarter, according to MSAI. Its share in store selling was up 100 basis points year-over-year to 10.2%, with Stokers now in stores representing 64% of industry volumes, which still provides a long runway for growth. Three was the marginal contributor to segment sales during the quarter. True sales declined 15% from the previous year. Stokers True was the number one chewing brand in the quarter, gaining 240 basis points of share to 29.0% share, according to MSAI. Category volume was down 8.6% during the quarter, according to MSAI. driven by a larger decline in premium loose leads compared to discount brands, with TPB's products outperforming. Gross margin decreased 50 basis points, primarily due to mix, from free and a mix shift to discount loose lead products. Operating margin decreased 70 basis points to gross margin decline, higher sales and marketing costs, and increased shipping costs. Moving to new gen, where we continue to manage through a disruptive environment, with sales down 11.1% from the previous year, 24.9 million. Adjusted gross margins were up 110 basis points year over year, primarily due to the higher inventory write-downs in the prior year period. Adjusted operating income increased $2.5 million to $0.1 million due to higher freight costs from the PAC-TAC transition in the previous year and reallocation of segment costs. The business remained profitable despite the challenging environment. Moving to our balance sheet. We ended the quarter with $106.4 million of cash in the balance sheet and $127.8 million of available liquidity providing flexibility in capital deployment. I would note that we had an unusual inventory build year of close to $33 million in fiscal year 2022, driven by several factors. Our annual tobacco purchase for MSD was above our requirements last year, and our planned purchases will decrease this excess inventory over the next several years. We added inventory to scale new products, including Quipra in the U.S. and Canada, to prepare for increased distribution in 2023, and also built up inventory of ZigZag products to protect against logistical supply chain constraints early in the year. We expect to benefit from the overall inventory build and for inventory to trend down to more normalized levels over time. We repurchased 2.2 million of shares during the quarter and 10 million notional value for our convertible bonds for 9 million. We continue to closely monitor the financing markets ahead of our July 2024 convertible note maturity. We believe our current cash balance and free cash flow generation provides us with optionality to adjust that maturity. We recorded approximately 35 million of non-cash asset impairments during the quarter, mostly related to new gen intangibles in our minority investments. Onto guidance. Given expected weakness in Q1 due to contracting trade inventory and realignment of internal resources, we currently expect consolidated adjusted IPTA of 88 to 94 million for fiscal year 23. As Graham mentioned, Based on the midpoint, we currently expect a year-over-year decline in Q1 EBITDA, but expect year-over-year stability and adjusted EBITDA for the balance of the year. Other projections include effective income tax rate of 22% to 24%. We expect CapEx to be temporarily elevated this year at approximately $13 million, with $9 million related to a manufacturing project we expect to complete this year. This compares to $7.7 million the previous year, of which $4.6 million was related to the manufacturing project that offers an attractive rate of return. We expect CapEx to return to more normalized levels in 2024. We expect to spend 12 to 15 million in capitalized software implementation costs related to our ERP and CRM implementation, which is currently on track and expected to be completed by the end of the year. We continue to carefully evaluate potential PMTA spend related to our modern rural products, all of which have been accepted by FDA. Let me turn it back to Graham.

Before I open the call to Q&A, I wanted to give you some thoughts on why I'm so excited about the long-term opportunity we have in front of us. When looking past the transitory disruption we anticipate early in the year, the following inherent strengths will drive performance. We have a portfolio of iconic brands that consumers love. ZigZag is the number one rolling paper and wraps brand in North America that's benefiting from secular growth trends and cannabis consumption with a compelling opportunity in front of us. We've entered a new category in lighters with a proven global brand in Clipper that significantly expands the addressable market we compete in. Stoker's is the number one loose-leaf brand, and Stoker's Moist Snuff remains one of the fastest-growing brands in the category where we crossed 10 Sharon stores selling for the first time last quarter with a sizable market we have yet to penetrate. These brands are being sold, distributed, and marketed by our world-class team and our entire organization is aligned towards driving organic growth and being financially disciplined to create shareholder value. Thank you for participating in the call today. And with that, I'd like to open the call for questions.

Thank you. If you would like to ask a question today, press star followed by the number one on your telephone keypad. Your first question today comes from the line of Vivian Azar with Cowan. Your line is now open. Thank you.

Good morning. I want to start on the zigzag segment, please. Obviously, you're cycling multi-year toward growth driven by innovation. But ultimately, I think for the street and for investors, this is a hard segment to kind of track given the non-track channel exposure. So can you just offer some commentary on the competitive landscape, please? Thank you.

Yeah. Hi, Vivian.

Look, I think the interesting aspect of the portfolio of ZigZag products is we have a wide range of products for the end consumer, whether it's tobacco wraps, hemp wraps, papers, cones. Generally, the way we look at it is the end markets are healthy for our consumers, and there's always a little bit of noise with ins and outs with launching new products and seeding the marketplace. We generally just feel really good about the end markets and our share growth profile in Q4 across a number of our zigzag products.

And is there anything to call out competitively?

Hi, Vivian. This is Summer. I think I would just add from the competitive perspective that we are monitoring that external competitive environment very closely and remain focused on continuing to grow the Zig-Zag brand and continuing to focus on the long heritage and quality that Zig-Zag brings to market while monitoring the competitive environment very closely.

Okay, fair enough. And then given the revised approach to guidance, which seems more than appropriate, segment level revenue ranges is probably more detailed than justified for the size of the business. Maybe if you could just contextualize how you're thinking about what, like, durable medium-term top-line growth is? Because, you know, double-digit tiger over the last five years, you know, reflects a lot of benefits from COVID, a lot of benefits from outsized growth from ZigZag, which probably needs to be normalized. How do you think about top-line over the medium term? Maybe just for the core tobacco segment. Thanks.

Yeah, so, you know, as Graham mentioned earlier, we've got some adjustments that we're making in Q1 on the trade-in course. What we are seeing is more encouraging growth. trends in the sell-through side, so what you'll see in the back half of the year for us is we do think that we normalize back to growth for zigzag and stokers.

Okay, fair enough. Thank you so much.

Your next question comes from the line of Eric Deloriers with Craig Hallam. Your line is now open.

Great. Thank you for taking my question. First one for me is also on the zigzag competitive side. One of your competitors there recently received a court order to stop selling certain products based on false claims. Just wondering if you see this as more of an opportunity to take share or if this is perhaps something that you see as more of like a marketing warning to the industry at large. So just wondering if you could comment on what you see as this in respect to an opportunity to take share and if there's any early feedback from some of your alternative shop customers in response to that. Thank you.

Yeah, thanks for that question. We, as you noted, have been following that activity very closely. We have been engaged with both our consumers and especially our retail customers, to your point, because they're interested in what's going on in the market as well. I think for us, we believe it's important to really stay focused on ZigZag. We have a long-standing reputation of bringing high-quality products to market, continuing to focus on bringing that new product innovation to market and reinforcing all of those benefits to our customers and our consumers to reinforce that brand love that everyone has for ZigZag.

Okay, that's helpful.

sort of Q1 inventory weakness guide. Was I hearing that correctly? That's primarily within Zigzag and I suppose if so, could you provide some commentary on how that might be impacting the various sub-segments within Zigzag? It sounds like perhaps weaker on some of the Clipper areas. Not sure if this is impacting you know, wraps as much as it is rolling papers and cones. If you could just, you know, provide some commentary if you're seeing this impacting some sub-segments more than others, that would be helpful.

Yeah, thanks, Eric. Yeah, so it's really more on the papers and wraps, so kind of some of our legacy products that we've kind of stopped with our trade for a while. And so it's really what we view it as an adjustment in Q1 to kind of return to more normalized levels beyond that.

Okay, that's helpful. And then last one from me here. So just wondering if you can provide maybe just a bit more commentary on the competitive dynamics you're seeing within MFT. You know, Stoker is obviously, you know, very well positioned in that value segment, obviously continuing to benefit from consumer downtrading really for, you know, seemingly a few years here now. Wondering if you're seeing any renewed push from competitors in that value segment. I mean, obviously you guys have you know, kind of a strong competitive advantage with that in-house manufacturing of those products. But just wondering if you're seeing any, you know, renewed push from competitors into that value segment and just overall commentary on some of the competitive dynamics within MST would be great. Thanks.

Yeah. Hey, Eric. This is Graham. Look, I think that that category is generally stable from a competitive perspective and no sort of amplified or different activity from the competitors that's beyond what you would sort of consider normal business at this point in time. And Stoker's had a strong quarter in Q4. We grew volume. We grew share. Last year, we were able to carry the pricing activity throughout the year That was amplified by being able to pull a price increase forward for our tub product, which ended up benefiting us throughout the back half of the year. The brand's strong. It's performing 10 share across the 10 share line in store selling. We feel good about where we're positioned right now to continue growing. Plus, we've got a lot of runway with 35% of the volume that we don't compete in. I think generally we feel like we're confident in the Stokers MST brand.

Yeah, sounds very encouraging. Thank you for your questions.

As a reminder, if you would like to ask a question, press star then the number one on your telephone keypad. We'll pause for just a moment for any final questions. There are no further questions at this time. I would like to turn the call back over to the Turning Point team for any closing remarks.

I wanted to thank everybody for joining the call today. I look forward to speaking again here in a couple months.

This concludes today's conference call. Thank you for attending. You may now disconnect.