Turning Point Brands Q3 2023 Earnings Call Transcript

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November 8, 2023

There are 8 speakers on the call.

Operator

Morning, and welcome to the Turning Point Brands Third Quarter 2023 Earnings Conference Call. All participants will be in a listen only mode. All lines have been placed on mute to prevent any background noise. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded.

Operator

I would now like to turn the conference over to Louie Refomena, Chief Financial Officer. Please go ahead.

Speaker 1

Thank you. Good morning, everyone. This is Louis Reframina, Chief Financial Officer. Joining me are Turning Point Brands' President and CEO, Graham Purdy And Chief Revenue Officer, Summer Frieden. This morning, we issued a news release covering our Q3 results.

Speaker 1

This release is located in the IR section of our website, During this call, we will discuss our consolidated and segment operating results, provide a perspective on the operating environment and our progress against our strategic plan. As is customary, I direct your attention to the discussion of forward looking The cautionary statements in today's press release and the risk factors in our filings with the SEC. On the call today, we will reference our non GAAP financial measures. These measures and reconciliations to GAAP can be found in today's earnings release, along with reasons why management believes they produce useful information. I will now turn the call over to our CEO, Graham Purdy.

Speaker 1

Thanks, Louie.

Speaker 2

Good morning, everyone, and thank you for joining our call. Our 3rd quarter results were in line with our expectations and demonstrated continued progress against our plan. During the September quarter, we showed double digit revenue growth at Stoker's and sequential stability in the Zig Zag segment notwithstanding the year over year comparison As we continue to gain traction from the alternative channel initiatives we have put in place. Given our performance through the 1st 9 months of the year, We are raising the bottom end of our EBITDA guidance from $90,000,000 to $92,000,000 with the range now $92,000,000 to 95,000,000 From $90,000,000 to $95,000,000 As we finish up this year and move into 2024, we are particularly excited about our national rollout of our MARGARON Oral White pouch nicotine product called Free, that's F R E. This product will compete in a category that's already worth over $1,000,000,000 in wholesale revenue Currently growing 40% to 50% per MSAI.

Speaker 2

Up until now, we've spent most of our time over the past year shoring up supply chain to ensure consistent product quality, analyzing consumer feedback and testing online select in store marketing And merchandising programs to ensure a successful national rollout. Given our progress to date, we are now focusing on prudently ramping up our sales and distribution efforts Our early learnings and performance in test markets have given us more confidence to now leverage our sales and distribution expertise profitably expand free profile and store count similar to what we achieved with Stoker's Moisten Up over time. We look forward to providing updates on this exciting new product in the quarters and years to come. Stoker's had another strong quarter with revenue up 10.1%, An acceleration from 7.3% growth in the June quarter, reflecting overall volume and market share gains As its quality to value proposition continues to resonate with consumers, Doker's continues to be a steady growth engine with a long runway for volume growth And favorable pricing dynamics. Zig Zag sales were consistent with the last quarter, but faced a tough comp from the previous year due to promotional activity, Initial Clipper load in, timing of Canadian paper deliveries and the discontinuation of a low margin product line in Canada.

Speaker 2

Despite this transitory dynamic, we're confident that the Zig Zag brand continues to strengthen based on a number of factors we track. Our sell through was better than our reported year over year results and we are encouraged by our wholesale customers and retail This is particularly true in our alternative channel where Zig Zag and its growing portfolio efficiently fills out our customers' inventory To better satisfy the growing demand from end consumers, both factors are expanding our addressable market. We are having success not only winning new untapped alternative customers across the brick and mortar and alternative distributor network, where we are also seeing existing alt customers buying a more complete zigzag As a result, we've seen healthy increases in average order sizes across the alternative space, while providing the Zig Zag brand with more valuable shelf and merchandising real estate within these stores to build brand awareness as we satisfy evolving in consumer preferences. As you know, the alternative channel is consistently expanding by virtue of additional states greenlighting medical and recreational cannabis, As well as attempt to provide a better shopping experience for consumers. In addition to more legal dispensaries and manufacturing and processing facilities, Other retail outlets like head shops are drafting off this trend.

Speaker 2

Our alternative B2B business saw zigzag sales accelerate growing over 40% during the quarter. We also continue to be proactive in optimizing our capital structure and opportunistically purchased another $15,000,000 notional of our convertible notes during the 2nd quarter, Bringing the total purchase as of the end of the quarter to $54,000,000 while maintaining a strong cash balance to help address future maturities. Moreover, today we announced the formation of a $75,000,000 ABL revolving credit facility, which Along with the cash on hand and projected future free cash flow allows us to comfortably address the maturity of our convertible notes next summer. Lou will discuss details later in the call. With that, let me hand the call over to Summer to walk through some progress and results

Speaker 3

Thank you, Graham. As discussed in prior quarters, Our focus on growing the Zig Zag brand remains a critical element of our plan. We continue to execute against our multiyear roadmap solidify Zig Zag as a lifestyle brand, especially in the alternative channel, which Graham noted. There is significant value of growing brand awareness, Trial and conversion and ultimately becoming a ubiquitous brand that a consumer is able to find anywhere. As Graham mentioned, we had another strong quarter in our B2B Alt segment, which saw an acceleration in our core Zig Zag Papers and cones portfolio.

Speaker 3

We saw a double digit increase in the number of customers and orders on our alternative platform with a healthy increase in average order size. We made significant progress across the business this past quarter as we saw growth in every subcategory with the alt channel, which includes head shops, smoke shops, dispensaries, including MSO owned distributors, cultivators and manufacturers and processors. Additionally, we are seeing increased engagement across our digital platforms. Total online traffic Session on our dedicated B2C site are up 33% versus year ago. Our investment into organic SEO Since early 2020 has placed Zig Zag into an optimal situation across the digital atmosphere, with over 10,000 plus branded and non branded Optimization has driven an approximately 70% increase for the channel's organic search visitorship since 2022.

Speaker 3

We've also seen an increase in returning and repeat customer rates. Further, last quarter, we shared the Exciting news of launching in Zumiez as part of our commitment to continuing to expand our sales channel. As a reminder, Zumiez is one of the largest Brick and mortar specialty apparel stores with over 600 locations across the United States. Due to successful progress and consumer interest and purchases thus We've already had the opportunity to expand into additional stores. We look forward to continuing to provide updates that showcase the momentum and Turning to Clipper, we continue to build consumer awareness through our efforts both in store and online.

Speaker 3

The engagement in our social channels highlight that consumers are interested in the points of difference of Clipper versus competitive lighter brands By way of significant and increasing engagement, throughout the quarter, we saw our social media follower growth, Total consumer impressions and content interactions grow, driven in particular by showcasing the unique features of Clipper. As noted in previous calls, we believe this category is complementary to our existing business and we continue to see the synergies Coupling Zig Zag and Clipper together with healthy demand for Zig Zag branded Clipper Lighters. Moving to Smokeless, Graeme covered the As more consumers are entering the Stoker's franchise because of the value proposition, We've continued to see more engagement with the brand across our digital properties. Building this engagement is an essential part of our strategy As we continue to see adult dippers transition to Stoker's and remain with the brand over time. We are also excited about our upcoming broader push on free.

Speaker 3

The early receptivity and engagement has been encouraging thus far as our differentiated nicotine offerings are resonating with our customers and consumers. In summary, we continue to focus on maximizing the value of our brands, executing against the plan we've established and growing our business with both our retail and end consumer. We continue to focus on maximizing the value of our world class brands Let me now turn the call back over to Louis to go through our results.

Speaker 1

Thank you, Summer. Starting with our consolidated quarterly results. Q3 sales were down 5.6 percent to 101,700,000 Gross margin was up 180 basis points to 50.7 percent due to segment and product mix. Adjusted EBITDA was $4,400,000 which was stable from the previous year. Going into segment performance.

Speaker 1

Zig Zag sales decreased 10.2% year over year, $46,800,000 but stable sequentially. Our U. S. Papers and Wrapped businesses were down due to promotional activities during the previous year period We're up sequentially. Our e commerce business, particularly B2B alternative sales grew double digits.

Speaker 1

Our Canadian and other smoking accessories categories saw declines during the quarter, primarily due to favorable timing of Canadian deliveries in the prior year period And a discontinuation of a low margin third party product line, which impacted sales by $1,800,000 during the period. Gross margins increased 330 basis points to 57.2% during the quarter, driven primarily by product mix, including the impact of the Clipper load During the prior year period and discontinuation of the low margin product line, Stokus products net sales increased 10.1% $36,900,000 in the quarter with a 2.2% volume increase and 7.9% pricemix increase. Net sales for the MST portfolio grew double digits. Focus volume was up 4.6% despite category volume down 5.3%, With share growing 70 basis points year over year to 7.0% during the quarter according to MSAI. Its share in store selling was up 70 basis points year over year to 10.5%, with Stoker's now in stores representing 67% of industry volumes, which still provides a long runway for growth.

Speaker 1

Chew sales were up low single digits from the previous year. Focus 2 was the number one tuning brand in the quarter, gaining 220 basis points a share to 30.6% according to MSAI. Overall, TPB loose leaf volume was up 0.4% versus the category which declined 3.1%. Category performance was driven by a larger decline in premium loose leaf with TPB's volumes benefiting from customer trade down as focused volumes grew from the previous year. Our free sales more than doubled off a low base as we started expansion of the product.

Speaker 1

Gross margin increased 120 basis points to 55.7 percent, primarily due to MST pricing gains. Moving to CDS, which was restructured during the quarter to eliminate certain unprofitable businesses and focus on a narrower set of products To better position it as a standalone business, sales were $18,000,000 gross margin was 23.8%. Moving to our balance sheet. We repurchased $15,000,000 notional value for our convertible bonds during the quarter. We ended the quarter with $96,100,000 of cash on the balance sheet.

Speaker 1

We also closed on a $75,000,000 ABL facility It provides the company with further flexibility and along with our cash on hand and free cash flow generation, ample liquidity To address the maturity of our remaining $118,500,000 convertible notes through July 2024. We now have liquidity to allow us to reduce our net and gross leverage to within a target of 2.5 times to 3.5 times range after addressing the conversion. Moving to guidance. We now expect consolidated adjusted EBITDA of $92,000,000 to $95,000,000 For fiscal year 2023 compared to our previous outlook of $90,000,000 to $95,000,000 Other projections include Effective income tax rate of 24% to 26%. We now expect CapEx to be approximately 8,000,000 Compared to $13,000,000 previously, with the difference due to timing of payments related to our automation projects that are now scheduled for 2024.

Speaker 1

We expect to spend $12,000,000 to $50,000,000 in capitalized software implementation costs related to our ERP and CRM implementation, Which is still expected to be completed by the end of the year, although the timing of final payments may fall into 2024. We currently expect to spend approximately $2,000,000 for the full year on PMTA related to our modern oral products, which remain under review by the FDA. Now,

Speaker 4

let me turn

Speaker 2

it back to Graham. To conclude, despite this year's challenges, in particular navigating wholesale inventory reductions at Zig Zag Canada and contending with some difficult comparisons related to last year's Clipper load, we feel good about the business, particularly our progress in the Alt Channel and Free. We remain focused on demonstrating further progress for the balance of the year and into 2024. Thank you for participating in the call today. And with that,

Operator

Your first question comes from the line of Vivien Azer. Your line is open. Vivian, your line is open.

Speaker 5

Sorry about that. Good morning.

Speaker 6

Good morning, Vivian.

Speaker 5

So, Graham, I wanted to follow-up on your commentary on free. Certainly encouraging to hear given the robust trends that we're seeing from a segment level perspective, Just so that we don't get over our skis in terms of the modeling, how incremental do you think we should expect this to be in 2024? Thanks.

Speaker 6

Yes. Look, I think Q4 is sort of the time of year where we're sort of expanding out the foundation. I think our expectation for the product is to look similar to Stoker's. Over time, as we compete against the large players in the category, Our share gains are generally small and incremental over a period of time.

Speaker 5

Certainly. And there are some kind of geographic nuances to market share across the competitive landscape in the modern oral category, can you speak to how you guys are thinking about targeting geographically to optimize your share opportunity?

Speaker 6

Yes, for us it's not necessarily geographical focus on the product, it's really a store output Focus on the product similar to some of the past practices we've had with other categories, specifically Stoker's, MST, and we focus on the stores that have the highest volume.

Speaker 5

Totally reasonable. And maybe just pivoting to Stoker, so obviously modern orals weighing on The moist milk list of that category broadly, Stoker is uniquely continuing to consolidate share, which is great to see. But can you comment at all On how you've seen the competitive pricing landscape evolve as competitors shift their focus towards modern oral? Thanks.

Speaker 6

Yes. It's well, obviously, we keep a very close eye on it. Stoker's has been a really nice success story for this company. I think as of late, You've seen some of the large competitors engage more strongly in the discount category. And so we're mindful of that, but I think We keep our head down.

Speaker 6

We keep focused on doing what we do. We certainly believe in our unique proposition, quality above all else, certainly with the value. And of course, the tub It's a unique offering for the consumer and provides a unique value proposition. So I think we're mindful as Competitors sort of sort out their go to market strategies and we continue to focus on the things that we do well.

Speaker 5

Perfect. I'll just squeeze one last one in on Zig Zag. Very nice margin expansion. You noted, Louis, some discontinued ops, which were helpful. But how should we think about and you commented on product mix As well as the benefit, but how should we think about channel mix as you continue to push towards nontraditional outlets?

Speaker 5

Thanks.

Speaker 1

Yes. From a gross margin perspective, obviously, we're agnostic in terms of where we're selling it to. But what we're seeing in the B2B side is Comparable to the gross margin that we're seeing on the core side.

Speaker 5

Okay. That's awesome. Thanks.

Operator

Your next question comes from the line of Michael Legg. Your line is open.

Speaker 4

Thanks. Good morning. Congrats on the quarter. Wanted to dig a little bit more into the critical penetration. How far do you think along you are with the AT 200 plus distribution outlets?

Speaker 4

How What type of penetration do we have so far? Where do we expect to get?

Speaker 1

Yes. We haven't disclosed The kind of the stores that we are broken into obviously that's competitive intel that we're keeping close guarded. But I would say is what we disclosed before was that the lighter mark And the U. S. Canada is about $500,000,000 with about Clipper having about 3% share of that market.

Speaker 1

So we're around that level and building up is how we think about it.

Speaker 4

Okay. Can you give us a little more detail on the promotional activity you saw with Exact last year, please?

Speaker 1

I'm sorry, can you repeat that?

Speaker 4

The promotional activity that you referred to last year that you compared The JEG sales team talk about what the promotional activity was and what type of impact you think that was?

Speaker 1

Yes. So what we had said was last year in light of the inflationary environment, we tested some promotions To gauge kind of customer receptivity, it ended up being stronger than we thought, which led to that $5,000,000 impact. So that was a combination of both The impact of those promotional activities as well as some timing of deliveries with one of our Canadian distributors last year. So those were headwinds that we faced. And we also mentioned this year, we discontinued a Canadian product line that was basically a low margin loss leader for Our operations out there, that was $1,800,000 of impact.

Speaker 1

We'll have another $1,400,000 of that next quarter as you think about the model and then another $1,000,000 in Q1 of F next year before we anniversary that comp. This year, we didn't mention it in our Earlier in our earlier commentary, but we also saw some destocking in Canada, which we think impacted sales by another one point $5,000,000 during the quarter.

Speaker 4

Okay, great. And then just on the All Channel, can you talk about how the penetration Is occurring, is it are they calling you? Are you calling them? Are you displacing anyone or is it just all growth?

Speaker 3

Yes, I'm happy to take that question. This is Summer. We continue to see Citing growth in the alt channel. And I think to your question, it certainly goes both ways, us calling them, them calling us. But I think even coming out of last night's exciting win in Ohio, if you think about that overall business opportunity when coupled with D.

Speaker 3

C, it means that nearly half of the State has access to a legal rec market, so we continue to focus on getting more product Into those customers, we saw great progress with our core paper line in the quarter. So not just growth based on innovative Products and we continue to work on being more of a solutions provider for all of those customers.

Speaker 4

Great. Thanks guys. Congrats on the quarter. Thanks.

Speaker 2

Thanks, Brian.

Operator

Your next question comes from the line of Eric De Lourdes. Your line is open.

Speaker 7

Great. Thank you for taking my questions. First one from Cliff around me. So I understand you kind of want to be a bit more I left about exact distribution and whatnot. I was wondering if you could maybe just help us understand what you're seeing with current inventory trade dynamics, when you expect Sort of that headwind to perhaps turn into a tailwind and when you're kind of expecting Clipper sales to, I guess, resume some growth here?

Speaker 1

Yes. So we've kind of said about the Clippers initially or any new product, and this you've got this load period where you have strong sales. And then you go through this period of what I would call kind of a lull as the trade absorbs that inventory. We're in that lull period today and we expect kind of Sales kind of bounce back kind of as we enter 2024 and go through the year.

Speaker 7

Okay. And then on free, I'm wondering if you can just Comments a bit more on the competitive positioning that you're expecting to kind of roll out with that product. You mentioned that the sort of playbook is going to kind of follow Stoker's from a distribution standpoint, going after stores with higher volume. Can you kind of comment on the competitive positioning that you're planning on having with Free as it relates to price point? Is this another Kind of value products similar to Stoker's?

Speaker 3

So while the strategy is similar to In terms of our approach and our growth expectations, we certainly are thinking about free as a more of a premium offering. We have strong belief in our point of difference, our USP, which is higher nicotine strength options available for consumers which we continue to see resonate both in store and strong response online and plan to profitably compete in the segment against those big brands.

Speaker 7

That's helpful. Next question is on loose leaf. I understood it's a smaller segment within Stoker's. I think this was the first sort of return to year over year growth that we saw in a while. Is this something that we should kind of expect going forward?

Speaker 7

Do you feel that you're Sort of a sustainable path forward, I understand it's a declining category. Are you seeing anything To suggest that this year over year growth isn't just a kind of one off this quarter or no real change to the overall kind of Competitive dynamics within that?

Speaker 1

I would say we've seen some accelerated share gains in our loose leaf Products, especially with our discount, loose leaf offering out there that's seeing growth. I wouldn't underwrite growth in this market going forward. I would say we're still expecting kind of From a sales perspective flattish to down, the good news with loose leaf over time is that it has shrunk as a percentage of the overall Stoker's business. It was 2 thirds of our segment when we IPO, now it's less than a third. So it's having less And the impact of sales with MST being the bigger driver going forward.

Speaker 1

So obviously, we're happy with the growth that we saw in the quarter, but that is not our

Speaker 7

That makes sense. And then just last one for me. Could you perhaps expand a bit on the margin impact of the discontinued product line in Canada? I guess, obviously, there was some promotional activity over the past year or so. We're now back up to that sort of 57% plus gross margin for Zig Zag.

Speaker 7

This more of a sustainable path or I guess sustainable level going forward? Or do you see a potential for some further margin gains now that this is This continued product line is phasing out?

Speaker 1

Yes. I mean, from here, I would say that the $1,800,000 came with Single digit gross margins that had a decent impact to our gross margins from a year over year perspective. The other thing is that as we mentioned, Clipper is in a low period now, and we mentioned those carry lower gross margins. So Clipper was down for us a year over year perspective as we were comping against the periods where we had that load last year. So our expectation is actually with some of the newer products that we have and the Clipper takes off that that should that may reduce our Gross margins over time.

Speaker 1

But again, our focus within the Zig Zag segment is increasing our gross profit dollars and leveraging the fixed cost SG and A that we have in that segment To grow our operating income. So we're not so focused on maintaining that gross margin levels, especially if we can get growth out of Clipper and some of our newer products that we're entering into the market with.

Speaker 7

That definitely makes sense. Thanks for the questions.

Operator

There are no further questions at this time. Graham Purdy, I will turn the call back over to you.

Speaker 6

Thanks, operator. I appreciate everybody joining us for the call today and we look forward to talking to you about another quarter from now. Thank you so much.

Operator

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

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Turning Point Brands Q3 2023
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